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RichardCox

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  1. Candlestick Formations: Spikes and Reversals As technical analysis becomes more and more popular in forex markets, it has become undeniable that Japanese candlestick charts dominate the landscape in terms of utility. This is because candlestick charts give us much more information in a single glance when compared to common alternatives like the line chart, the bar chart, or the point-and-figure chart. Candlestick charts give us the ability to differentiate between prior trend outcomes in clearer ways as different color bars are associated with different types of price movements. For example, if your bearish candlestick bars are shown in red then it will be easier to identify whether or not there is sufficient momentum in the market to initiate short positions if you see large groupings of red candles. The opposite would be true for your candle analysis if the bullish color scheme was showing something similar. This can be highly valuable information, especially if you are trading on small or medium time frames. Bullish/Bearish Spike Candles: Indicators of Market Extremes In addition to this, candlestick charts can be excellent in terms of the ways they can help technical analysis traders to identify market extremes. These extremes will often show themselves as price spikes that can occur in either direction and ultimately suggest that a reversal scenario is unfolding. Consider the visual examples below: With these examples, we can see that spiking candles can come in a few different reforms, so perhaps it is more useful to think of these price occurrences as belonging to a “family” of candle shapes rather than any single cookie-cutter format. Some of the names that are commonly used when these structures occur would include names like morning/evening stars, dojis, hammers, dragonflies, and pin bars (among others). The main point here is not in the name classification but in the fact that all of these candlestick structures mark a critical point of indecision in the market. On a real-time chart, examples of these types of events (both bullish and bearish) can be seen in the graphic below: This information can be highly valuable when assessing the true strength of the underlying trends that are visible in the forex markets. If an underlying trend is not able to sustain the market extremes that create these spikes, it starts to make much more sense to play things from the other direction. Price spike examples are shown in the red circles above, and these situations represent instances where traders would start to enter positions that oppose the directional momentum that had been seen during the preceding move. Real-Time Trade Example: GBP/USD As a hypothetical example, let’s assume that we are dealing with an uptrend in the GBP/USD. Higher highs and higher lows make up most of what is visible on the price chart, and we are considering taking a long position in the GBP/USD. We see the uptrend culminate in a 50-pip surge to hit resistance just below 1.59. But as this happens, the GBP/USD posts a bearish pin bar, which shows the price spike reversal in question: An occurrence like this would be an early indication that traders should start to consider short positions in the GBP/USD, as long as prices hold below the 1.59 resistance. Any violations here would mean that the spike high is not valid and that there is no real bearish reversal in place -- and this would mean that the trade should be closed. For price targets, an excellent early level to watch is the price level that marks the original surge in prices. This would suggest that the price level is a significant area of support, and there is potential for more bounces later. In our example above, this area comes in at 1.5849 and traders would start to take partial profits once we see a downside move into this price region. This does not mean that the trade should be closed out completely if this occurs but it would generally be a good idea to take part of your gains and to bring your stop loss to breakeven for the remainder of the position. Logical Basis For Trades: The Paradigm Shifts All technical analysis positioning is based on some sort of logic that is used to suggest one directional outcome is more likely than another. In this case, the appearance of price spikes suggests that a significant price move has reached its exhaustion point and there is not enough agreement in the market to create the number of active buy or sell positions that would be required to propel the trend further. This means that the paradigm has shifted and that it is time to start betting in the other direction. Confirmation of these events occurs once we can identify the break of a major support or resistance level. This can be seen in the chart example shown above. Bearish scenarios are confirmed by major support breaks, while bullish scenarios are confirmed by major resistance breaks. In both cases, the central point to remember is that the environment that was previously in place is now changing. So if you already have open positions in the direction of that trend, it is probably a good idea to close-out and take profits. If you are not already in a position that is aligned with the direction of that trend, it is probably a good idea to start planning out a contrarian trade. Tweezer Tops and Bottoms Last, we should take a look at the Tweezer formation, which is another incarnation of the spike highs discussed previously. The Tweezer formation is basically a “double spike” high or low that occurs at the end of a bullish or bearish trend. Trading probabilities for eventual reversal confirmation are slightly higher in these cases because the market has essentially made two attempts to continue with the prior trend -- only to fail later. In the chart graphic below, we can see examples of the bullish and bearish Tweezer structure. The underlying logic when trading a Tweezer Top or a Tweezer Bottom is the same as what would be seen with a standard price spike, so we will not go into further examples here. Instead, it should be kept in mind that the double-spike Tweezer candle structure has a slightly higher success rate in predicting the validity of true reversals in the underlying trend. Conclusion: Price Spikes Should Be Faded, Not Chased With all of this in mind, it should be understood that price spikes should be viewed with caution rather than enthusiasm. These are structures that indicate trends are ending, and this can be confusing in some cases because spikes are characterized by significant surges in momentum. This creates problems for some traders that might be unsure whether or not this is a continuation factor that should be chased rather than faded. But when we look at the ways these structures typically play themselves out, the opposing rationale makes much more sense. Price spikes and Tweezer formations are relatively easy to spot and they can be a powerful addition to any trading strategy. In most cases, experienced traders will not use these instances as a complete basis for a trade. Instead, they can be used to confirm a bias that has already been generated by other technical indicators or price structures. Price spikes can give us critical information about the underlying sentiment levels that are currently seen in the market for a given asset, and this can help you to improve trading probabilities when you are looking to enter into contrarian positioning.
  2. Understanding Order Flow in Forex Once forex traders have spent some time researching the market and in developing technical analysis techniques, it can be easy to assume that some of the basics have already been covered and no longer need to be explored. But this is an outlook that can create an increased potential for problems and lead to losses that might otherwise have been avoided. No successful trader ever feels as though he has masted all levels of the market and it can often be a good idea to revisit some of the market elements that might seem basic in nature. One of these elements can be found in the process of order flow, and this is a market element that can have massive influence on the trend activity that is likely to be found in in the future. Active Buyers and Sellers First, it should be understood that the market is simply a collection of buyers and sellers. When a trader enters the market and buys an asset, the active and available supply of that asset is reduced. When a trader enters the market and sells an asset, the active and available supply of that asset is increased. Rising supply levels are bearish for asset prices. Falling supply levels are bullish for asset prices. So when we are seeing positive trends we can understand that a majority of the market is making its position clear and this is what is sending prices higher. But it is possible to follow this logic further, as it does not only to apply to positions as they are opened. For example, a long position that is closed has the same market effect as if that trader has just opened a short position. A short position that is closed has the same market effect as if that trader has just opened a long position. For this reason, we tend to see retracements in market prices after considerable trending moves have been made. In an uptrend, this means that bullish traders are taking profits on long positions. In an downtrend, this means that bearish traders are taking profits on short positions. These events are what prevent trends from continuing ad infinitum, and this is the activity that defines the dynamics in most trading markets. Option Expiries Another factor that can has a massive impact on market prices is option expiration. A proper options tutorial is beyond the scope of this article. But it should be understood that options contracts are defined by an expiration period that ends the life of the position. There are many different options expiration times but there are often significant options orders that are closed at the end of a week, month, or quarter. This is significant because it tends to increase volatility in the forex markets during these intervals, and when traders are aware of these instances it can be easier to avoid significant surprises in market movements. For example, let’s assume that a major hedge fund has purchased call options in the Euro as a means for hedging risk in its Euro-denominated assets. These call options essentially represent a long position in the market, so the hedge fund needs the Euro to rise in order to gain profits in the position. To accomplish this, the hedge fund might buy the Euro near a major support level in order to prevent the market from falling below the strike price of the option. Hedge funds are typically able to command position sizes that dwarf the capabilities of individual traders and order flows of this size can lead to unexpected price moves in the market. This does not necessarily mean that forex traders should avoid positioning themselves in the market but it does mean that it is generally a good idea to keep position sizes smaller in situations where options expirations are likely to have a bigger impact on trending moves. In many cases, these situations will be alerted in the financial media. So, if you actively read the news wires that are most closely dedicated to your chosen trading assets there will probably be signals sent which suggest that hedge funds are actively establishing these types of positions. Central Bank Activity To be sure, hedge funds make up a very important section of the market. But an additional factor that many investors might not come from the impact that is seen when central banks place order flows in the market. Central bank order flow activity influences the forex market in ways that are much more pronounced than what is seen in areas like stocks or commodities. This is because central banks will directly buy and sell currencies in order to either restructure its balance sheet or to specifically influence certain sections of the market. This latter scenario is referred to as “currency intervention” and this type of event has created some of the largest percentage moves in the history of the financial markets. Chart Example: EUR/CHF Source: Yahoo Finance In the chart above, we can see a recent example of this using the EUR/CHF. The sharp declines that are seen in the middle of this price history (January 2015) were propelled by a decision by the Swiss National Bank to remove its established price floor in the CHF relative to the Euro. This led to a sharp surge in the value of the CHF as the decision implied that the SNB would no longer be selling its currency in an effort to depress its value. This lack of “resistance” from the SNB would then enable traders to buy the currency without fear of central bank intervention into the forex markets. The result was a massive decline in the EUR/CHF (positive for the Swiss Franc) and many traders positioned in the other direction were forced to deal with margin calls. Events like this are rare but central bank influence is not as central banks all over the world actively buy and sell currencies on a daily basis. Market outlets like Mocaz are highly efficient in alerting traders when these types of activities occur, so this type of information is something that should be on the radar of all forex traders that tend to base positions on shorter charting timeframes. Central banks will not be generating order flows that are used to hedge options positions but there is a good deal of data that should central banks tend to place orders near large round numbers and psychological figures. This type of order flow activity can contribute to increased volatility in these price areas. Conclusion: Order Flow Activity Can Contribute Heavily to Overall Market Volatility With all of these factors in mind, it should be understood that order flow activity can contribute heavily to market volatility at certain price levels. Technical traders tend to avoid market reports that deal with this type of activity on the assumption that all of the information needed is already contained in the charts themselves. But when we understand where order flow activity is likely to increase we are better able to structure technical positions in ways that reduce risk in the event of surprising changes in the underlying volatility. This can be critical in protecting a trading account against the prospect of margin calls if positions are overleveraged and the market starts to move sharply in the wrong direction.
  3. Opposing Approaches to News Trading For traders that spend time fashioning forex strategies that utilize fundamental analysis in some way, one of the best approaches is news trading. There are many reasons for why news trading allows traders to capture significant gains. For the most part, significant news events mark instances where the market is literally learning new information that might change the supply and demand dynamics for a given asset. This is just as true in forex markets as it is in stock and commodities markets, so it is a good idea to learn some of the techniques that might be used in order to capture profits. Here, we will look at two opposing approaches that can be used to capitalize on the high-volatility price moves that often accompany major news releases. Trading Against Price Spikes When important economic reports are released to the market, the biggest price swings tend to occur when there is a significant level of surprise in that information. For example, if most of the analyst community is expecting an economic report to be strongly positive, prices could fall substantially if the actual results surprise to the downside. In the reverse scenario, markets that receive a positive surprise will likely see rallies generated for the asset in question. When these price moves are substantial there are excellent opportunities to capture significant profits. This requires relatively swift action, however, because markets are usually moving very fast when these types of events are seen. These price spikes create opportunities when the initial movement is followed by a Hammer Candlestick Formation. For those that are unfamiliar with this term, a Hammer is a candle formation that is composed of a small candle body and a long wick that extends far in one direction. Hammers are typically thought of as reversal signals because they ultimately suggest that the prior trend is losing momentum. The resulting pattern then resembles a hammer, and these can be used to establish new forex positions. A visual example of a bullish Hammer formation can be found in the chart graphic below: When prices are falling and a bullish Hammer formation can be found, it is generally prudent to consider entering into long positions. When prices are rising and a bearish Hammer formation can be found, it is generally prudent to consider entering into short positions. This can be useful information for those that are looking to trade after significant news events. Consider the following example: In the chart above, we can see hourly price action in the USD/JPY. On this day, there was positive news to support the US Dollar and this created an initial rally in prices once that information was made public. Warning signals could be found, however, as a bearish Hammer formation is seen in the following period (shown at the downward arrow). Bullish traders quickly started to exit their positions and this turned the momentum in the bearish direction. What is most important to keep in mind here is that if there is strongly positive news and it fails to generate momentum in the upward direction, there is likely to be little reason in the minds of most traders to buy that asset. So, when Hammer formations occur after a significant news event, it is generally a good idea to trade in the direction opposite of the initial price move. This type of approach becomes particularly useful when the Hammer occurs at a significant point of historical support or resistance. If a news event is positive and prices rise only to form a Hammer at a closely watched resistance level, short positions become much more likely to succeed. If a news event is negative and prices fall only to form a Hammer at a closely watched support level, long positions become much more likely to succeed. Trading With Breakouts Of course, not all news events will result in a reversal. In fact, it is more likely that markets will continue travelling in the original direction as most traders are now reacting to a different paradigm effecting the underlying price of the currency pair. Because of this, it also makes sense to have a strategy to benefit from market continuations once major news events are released. The best approach in these cases is the Breakout Strategy, which will also uses important support and resistance levels in structuring trades. Consider the following chart in the EUR/USD: In this example, we can see that the day’s main news event was negative for the Euro, and prices in the EUR/USD were sold heavily in response. Fortunately, there was a clearly defined support level in the price activity that lead up to the economic release. This is significant because a scenario like this gives traders an opportunity to clearly structure trades based on both technical and fundamental analysis. When both of these approaches work in tandem with one another, there is a much greater likelihood that a trade will end in profitability. For those looking to enter into breakout trades into a news event, it is a good idea to have firmly established support and resistance lines leading up to the release. If this cannot be done, it might be a better idea to stay on the sidelines and not enter into a trade. But if these levels can be identified, traders can place limit orders on both sides of the market. Essentially, buy positions would be placed above the market price (just outside of the important resistance level) and sell positions would be placed below the market price (just outside of the important support level). If prices then move forcefully through those areas, one of the trades will be triggered and the other should be deleted from the trading station. “When looking to implement this type of strategy it should be remembered that there are often price gaps that could potentially miss your limit order,” said Brian Johnson, markets analyst at Teach Me Trading. “If this occurs, it is generally a good idea to remove the order as any retracements would likely be indicative of a price reversal.” Additionally, it should be remembered that stop losses should be kept very tight in these types of situations because the enhanced market volatility can lead to quick losses if there is no protective stop loss in place. In many cases, a pip count is the best approach when using stop losses. So, for example a trader might choose to place a 25 or 35 point stop loss on the assumption that a retracement in that amount would likely mean that markets are reversing. Conclusion: There is More Than One Way to Trade a News Event With all of this in mind, forex traders should understand that there is more than one way to trade a news event. The preferred method should depend on a few different factors. for example, traders that are not able to define clear support and resistance levels should not employ the Breakout strategy. Instead, it would be a better idea to watch for Hammer formations so that traders can play the potential for a reversal. In both cases, there is a strong need for tight stop losses because these events create scenarios where the markets are at their most volatile and unpredictable. For these reasons many traders prefer to “wait until the dust settles” and avoid news events. But when these strategies are implemented with quickness and efficiency, there is large potential for gains as market momentum builds.
  4. Trading Forex with Fractal Strategies The concept of fractals is something that can be applied to a wide variety of events and activities throughout the universe, and the fact that they are so prevalent is why many traders in the financial markets use fractals in their analysis. These ideas are somewhat complicated but fractals are essentially geometric patterns that repeat in increasingly smaller scales. These patterns create irregular shapes and structures that cannot be recreated using classical geometry. When applied to the forex markets, one of the most common approaches is to apply fractals to consolidation patterns and price channels. Those price channels and consolidation zones are then expected to act as support and resistance boundaries that can be used to establish trade entries when used in conjunction with other technical signals and indicators. The rationale for these trading decisions is based on the fact that since fractals appear broadly in nature, the patterns are expected to be repeatable in terms of what can be expected in market activity, as well. So, for example, any time you see a pattern repeating on a 5-minute chart, you will likely find similar patterns developing on the longer term time frames. In this way, it can be argued that fractal formations have some key attributes in common with patterns that are derived from the Fibonacci sequence. Fractals vs Basic Price Channels One distinction that should be understood is that there are differences between fractal formations and basic price channels. For the most part, there are two main differences. First, fractals can give more information than simple price channels in determining broader price trajectory. When fractals are layered upon one another, it becomes much easier to determine the trend and to forecast the distances price will travel once it breaks out of the fractal zone. So for example is there are 40 pips between the top and bottom of the fractal zone, it would be likely that prices would travel about 40 pips once price breaks out of the fractal zone (in either direction). This information can be very useful when setting stop losses and profit targets for your trades. Second, fractals are most useful in clarifying the price dynamics that are present in the market at any given moment. Once you have more experience constructing price fractals, it becomes easier to identify impulse moves in the market that are likely to determine the trends that follow. The central market activities that create the fractal formations require significant order flows (on the level of order flows that are generated by major financial centers like institutional banks and currency fund traders). For these reasons, fractals help traders identify moves that are likely to dictate the direction seen in upcoming trends. Chart Examples Now that we understand the basic rationale behind fractal strategies, it is a good idea to look at some visual examples of how these structures form on a price chart. Most of the larger trading platforms can automatically plot fractals for you. But here, we will do these manually so that we can identify some specific areas that highlight the logic behind the fractal trading strategy. In the chart above, we can see prices in a short term downtrend that is marked by three separate fractal formations (shown with downside arrows). Each of these price zones is worth about 50 pips and prices moved back in a more sideways direction once this series had run its course. We can also see that a bullish fractal occurred before the reversal came, and this change could have been spotted by traders that were watching for the price zones themselves to start breaking down. Once a trader could see that the 50 pip series was no longer valid, profits could have been taken on short positions and new long positions could have then been established. In this way, fractal formations can be much more valuable than simple price channels in determining potential trend direction and the eventual reversal. When we use basic price channels by themselves, it is much more difficult to identify profit targets because there is no association with actual pip values. In the chart above, traders would be able to identify profit targets in 50 pip increments. Basic price channels themselves would have only given traders an idea of the trend direction without any indication of which price level would be optimal for taking profits on short positions. It should also be noted that these fractal zones work as resistance zones as prices are moving lower. This is another area that is not possible to identify when using simple price zones (because for this you would need the pip values that are generated by the fractal formations). In the next chart, we can see prices in a short term uptrend that is marked by four separate fractal formations (shown with upside arrows). Each of these price zones is worth about 100 pips and this was followed by price activity moving in a more sideways direction after this series had run its course. We can also see that a bearish fractal occurred before that reversal, a signal that could have been used to close out long positions already established. In the chart above, traders would be able to identify profit targets for long positions in 100 pip increments. We can also see that the fractal zones work as support zones as prices are moving higher. In this way, the fractal zones will actually work as resistance turned support levels that can be used to determine whether or not the initial bullish trend has run its course and is ready to reverse. Trading Tips With these examples, we can see that fractals make it easier to separate trends using definable price zones. From a fundamental perspective, this makes a good deal of sense because of the way that large order flows tend to work themselves through the forex markets. “Institutional orders tend to be placed in individual flows that come in succession,” according to recent forex market reports from iForex. “This generates changes in price that unfold in a successive fashion.” This should be encouraging for technical traders as well, because it gives more credence to the strategies that use chart activity as a basis for trading decisions. And when fractals are identified, traders are able to define the bandwidth of pip values that will make up the trend that follows. In terms of trading tips, there are generally two approaches that can be taken when basing trading positions on fractal activity. Since fractals give us an idea of how far prices are likely to travel, we can use the fractal zones as support and resistance zones that create trade entries and profit targets. When uptrends are seen, trades can be established when prices move through the upper end of the fractal resistance zone. When downtrends are seen, trades can be established when prices move through the lower end of the fractal support zone. Alternatively, trades can be taken using retest strategies. When uptrends are seen, long trades can be established when prices move to hit the upper end of the fractal resistance zone, fail to break it, and then fall back to the fractal support zone. When downtrends are seen, short trades can be established when prices move to hit the lower end of the fractal support zone, fail to break it, and then rise back to the fractal resistance zone. As always, trading probabilities are enhanced when these signals are used in combination with other technical indicators. There are many different options available here. But since fractals are typically used to identify the strength or weakness in a trend, momentum indicators tend to be some of the most helpful tools when constructing trades.
  5. Trading with Dual Stochastics Many many new traders first get into the field of technical analysis, there is a good deal of terminology that must be mastered relatively quickly -- or at least before any real-money trades are actually placed. This terminology includes that long list of indicators and oscillators that have risen in popularity over the last decade. It seems as though a new indicator type of presenting itself every few months as traders attempt to develop new strategies for gaining an edge and increasing profitability when using technical analysis approaches. One of the stranger sounding names in the oscillators category is the Stochastics oscillator, which is a technical trading tool that tends to have more users in the realm of forex than in any other asset class. As a quick reminder, the Stochastics oscillator is a gauge of momentum that relates closing prices in an asset to its range of price activity over a specified period of time. Most traders tend to use the default settings when the Stochastics oscillator is made available on the trading station, but there are some alterations that can be made in the oscillator depending on the type of signals that you want to receive. Specifically, the oscillator becomes less sensitive to new price moves in the market when the time period is adjusted or when traders instead plot a moving average of the Stochastic readings themselves. In most cases, the standard formula is used to calculate the Stochastic reading, and this formula is shown below: %K = 100[(Closing Price - 14-period Price Low)/(14-period Price High - 14-period Price Low)] For those less mathematically inclined, this results in a final reading that will allow traders to assess whether the price of the asset has become overbought or oversold. Definitions for both of these characterizations differ in some circles: Aggressive traders view readings below 30 as being oversold where 70 and above suggests the asset has become overbought. More conservative traders tend to wait for more extreme signals and use 20 and below as the criteria for oversold readings (along with 80 as the threshold for overbought signals). The underlying logic for the Stochastics calculations is that prices tend to close near their highs when markets are in an uptrend (and close near their lows when markets are experiencing downtrends). Some charting stations show the Stochastics reading as a single line (the %K line). Other charting stations will add another line (the %D line), which is essentially a 3-period moving average of the reading shown in the %K line. Establishing a Dual Stochastics Strategy Now that we have an understanding of the basic calculations and logic that is behind the Stochastics oscillator, it makes sense to start developing new ways of using the indicator. This is the only way that traders can truly gain an edge on the rest of the market, where the exact same signals are being sent to everyone using these indicators and oscillators with their default settings. One alternate way of using Stochastics is to combine a fast Stochastic with a slow Stochastic and then to identify areas where each indicator moves to opposing extremes. This dual Stochastics trade can generate many signals that are not readily apparent to those that are basing Stochastic strategies on the default methodology. In this case, the 80% and 20% thresholds will be used, as these offer better extremes and reduce the number of false signals. We will also be using a 20-period EMA as an additional trigger signal that is used to validate any potential trade ideas that might be identified. This EMA is not completely required for the dual Stochastics system but there are some added advantages that can be captured when putting this extra trading indicator on your charts. When setting up your indicator parameters, the following settings can be used: The slow Stochastic calculation is based on a %K of 21, Slowing parameter of 10, and a %D parameter of 4. The fast Stochastic calculation is based on a %K of 5, Slowing parameter of 2, and a %D parameter of 2. For the slow Stochastic reading, the “signal line” field is used and the “main line” field is left blank. For the fast Stochastic reading, the “signal line” field is left blank and the “main line” field is used. If you are using the Metatrader platform, this is how the platform should be configured for the slow Stochastics: This is how the platform should be configured for the fast Stochastics: For each of these Stochastics lines, you will want to use different color lines, as this makes it much easier to spot trading signals as they unfold. For actual trading criteria, there are some additional rules that should be remembered when using the dual Stochastics strategy: Prices should be in the midst of a strong trend (in either direction) Stochastics readings for both lines should extend to opposing extremes Wait for a retracement to the 20-period EMA and a supportive candlestick formation that indicates short-term reversal before entering into the position Some traders will use the mid-line in the Bollinger Band indicator rather than using the 20-period EMA Next, we will look at some examples of the dual Stochastics strategy at work. For the most part this strategy is employed on the middle time frames (ie. 1-hour charts) but the same rules can be applied to longer time frames, as well. In the example above using a chart history in the USD/CHF, we can see two different price points that could be used for new trade entries. The forex pair has started to generate a strong series of higher highs and higher lows, which meets the first criteria for new trade entries using the dual stochastics strategy. In both cases, prices break above the 20-period EMA and then fall back to test the supportive effects of the indicator. As this occurs, there is an extreme difference seen in the activity of the fast and slow Stochastics as one of the indicators falls into oversold territory while other other rises into overbought territory. Adding to the bullish bias are the candlestick formations that are seen as these developments occur. In both cases, doji candles are followed by bullish engulfing candlestick patterns. Added information on the engulfing candlestick pattern can be found in this article. In this example, we can see that the extreme differences between the slow and fast Stochastics created a precursor that signalled the larger bull rally that followed, and the two potential entry points shown in the example above would have generated significant profits if identified early. “Significant differences that are showing simultaneously between short and long term indicators suggest that the early-stage trend activity is likely to continue,” said Michael Carney, trading instructor at Teach Me Trading. “These types of differences can be used as a basis for new positions when there are additional indicators confirming the position.” In this chart example, we can see the bullish case that is based on the arguments in the dual stochastics strategy. If an initial downtrend was present the same rules apply, only in reverse. The important part to remember here is that opposing signals must be sent by the dual Stochastics readings, as this ultimately suggests that the initial trend is likely to continue. In this way, the dual Stochastics strategy should be viewed as a continuation structure and that probability for success are greater when one or more additional factors (EMA activity, candlestick patterns, etc.) are present.
  6. The Blade Runner Strategy Many traders on this forum are likely fans of the sci-fi classic BladeRunner, Ridley Scott’s dystopian depiction of future world increasingly dominated by artificial intelligence. So, it might come as little surprise that there is a forex technical analysis strategy boasting the same name. The strategy relies heavily on the position of market prices relative to the historical averages. It could be argued that the majority of technical analysis strategies start with a basis that is vaguely similar. But variations on the Blade Runner strategy that employ the use of the forex polarity indicator offer a somewhat unique approach to moving averages. Here, we will look at some of the factors involved when forex traders place trades using the Blade Runner method. Basic Concepts Trading signals generated by the Blade Runner strategy are based on pure price action. Off-chart indicators are not needed, but can always be added as a source of added confirmation. Instead, most of the focus is placed on price activity itself, which means that the use of support and resistance levels, pivot points, and candlestick formations might prove beneficial when looking for new opportunities. In most cases, the Blade Runner Strategy uses a 20-period exponential moving average (EMA) or the middle line of the 20-period Bollinger Band. Time frames can vary, but many traders argue that the strategy is better-suited to short-term charts as it provides signals for quick entries and exits. The term “Blade Runner” is used because the EMA (or Bollinger Band middle line) cuts through price activity and provides a reference point for the trading signals that are sent. Trading Signals The trading signals that are sent using this strategy are sent when prices convincingly trade above or below the EMA, and then test the EMA on more than one occasion. Below, we will look at two examples in the bullish and bearish directions. First, we will look at a bullish example using a daily chart in the EUR/USD: Here, we can see that prices have tested the 20-period EMA on five separate occasions before stalling out toward the right of the chart. Bears are not successful in convincingly driving prices below the 20-period EMA. This sets the stage for further rallies later, once markets consolidate and correct themselves in-line with the longer-term trajectory. Once a signal like this is spotted, it becomes increasingly likely that prices will reject to the topside, once the period of sideways consolidation (found at the right section of the chart) has completed. In the next EUR/USD chart, we can see how this scenario might unfold: Here, we can see that the initial rally then encounters its periods of corrective consolidation. This period gives the market the energy it needs to propel itself further once the averages have corrected. Long positions could have been taken in this scenario, and carried for profits until the final candles on the chart, which is where prices convincingly break in the bearish direction. Rules for the Bullish Entry: Price activity moves convincingly above the 20-period EMA Prices test the EMA from above on multiple occasions Prices enter a period of consolidation Prices then finally break back convincingly above the EMA Trades are closed once prices convincingly fall below the EMA Bearish Example Next, we will look at a bearish example using a daily chart in the USD/JPY: In this scenario, we have a somewhat more volatile example that shows signals in the bearish direction. We can see that prices have tested the 20-period EMA from below on four separate occasions before stalling out toward the right of the chart. Bulls are not successful in convincingly driving prices above the 20-period EMA. This sets the stage for further declines later, once markets consolidate and correct themselves in-line with the longer-term trajectory. Here, it becomes increasingly likely that prices will reject to the downside, once the period of sideways consolidation (found at the right section of the chart) has completed. In the next USD/JPY chart, we can see how this scenario might unfold: Here, we can see that the initial decline later encounters its periods of corrective consolidation. This gives the market the energy it needs to propel itself further once the averages have corrected. Short positions could have been taken in this scenario, and carried for profits until the final candles on the chart, which is where prices convincingly break in the bullish direction. Rules for the Bearish Entry: Price activity moves convincingly below the 20-period EMA Prices test the EMA from below on multiple occasions Prices enter a period of consolidation Prices then finally break back convincingly below the EMA Trades are closed once prices convincingly rise above the EMA Of course, there are variations on these rules -- as there are with any forex technical analysis strategy. Next, we will look at one of these variations. Specifically, we will look at the ways trades can be constructed when we add the Forex polarity study. Adding the Forex Polarity Study Some traders are reluctant to try any strategy that employs a single trading signal. There is good reason for this, so next we will look at some of the ways traders can add Bollinger Band readings in order to gain added confirmation. This is also referred to as using the Forex Polarity study, which juxtaposes the 20-period EMA along with the middle line in the 2-deviation Bollinger Band. Here, we will look at a bullish example of this combination using a daily chart in the GBP/USD: In this chart, we can see that the GBP/USD encounters a period of consolidation toward the left side of the chart The 20-period EMA and the middle like of the 2-deviation Bollinger Band are then viewed in combination. Once prices forcefully rise above this combined signal, we have a scenario that lends itself to bullish trades and long positions for the currency pair in question. This chart might appear complicated and difficult to understand at first glance. There are Metatrader indicators that plot the 20-period EMA and the middle line of the 2-deviation Bollinger Band, and this can make the entire structure easier to understand and assess at first glance. But we have plotted all relevant indicators together here for better frame of reference and understand how all of these indicators work in combination with one another. When a bullish signal like the one shown in the chart above becomes apparent, it becomes more likely that markets will experience additional upside in the trading periods ahead. This combined signal might be viewed as more valid, given the combined nature of the indicators involved. Most traders prefer not to use any trading signal in isolation, and many of these difficulties can be solved when using the Forex Polarity study as opposed to the 20-period EMA by itself. Conclusion: The Forex Blade Runner Strategy Offers a New Spin on the Traditional Moving Average Strategy In all of these ways, forex traders can use the Blade Runner strategy as a means for offering a unique take on the traditional moving average strategy. There are rules in place for the bullish and bearish versions of this strategy, and each of these steps should be honored before any real-time trades are placed. Most technical analysis strategies employ moving averages in some shape or fashion. But when we look at the rules established for the Blade Runner approach, alternative variations (and trading signals) can be identified.
  7. Candlestick Patterns: The Dark Cloud Cover Reversal One of the oldest sayings in financial market trading is that it is “best to buy low, and sell high.” But while this is a relatively easy idea to understand, it is much easier said than done. This is because if can be very difficult in some cases to identify situations where market momentum is truly changing. A trend, by its very nature, is a circumstantial event that requires a significant amount of market momentum to generate. This is why experienced traders are well-accustomed with the constant “head fakes” and false reversals that are seen on a regular basis. Needless to say, the ability to accurately buy low and sell high can be extremely profitable. So it makes sense for traders to have many tools in their arsenal that will allow these situations to be spotted as they unfold. Here, we will look at the Dark Cloud Cover, which is a Japanese candlestick formation that signals “trouble is on the wake” and that the bullish momentum needed to maintain an uptrend is starting to leave the market. Candlestick Pattern Dimensions The Dark Cloud Cover differs from patterns like the Doji or Evening Star in that it is a more decisive move that signals potential trend reversal. Dojis and Evening Stars are more an indicator of market indecision, and this can be seen when we look at the way the Dark Cloud Cover starts to separate from the trend. In the illustration above, we can see that the “cloud cover” is a bearish candle that follows a bullish candle as part of an uptrend. The highest high actually surpasses what was seen in the previous bullish candle. Price moves like this can be thought of as a “bull trap” because it can be easy to mistake this activity as a new higher high that is needed to support the uptrend. Closing activity in the period is the key here, however. When we see a negative close that falls below 50% of the bullish candle body, warning signals should start to flare up for those in long positions. If the next candle is also bearish, our Dark Cloud Cover pattern is confirmed and it makes sense to start thinking about shorting the asset. Pattern Rationale The supportive logic behind the pattern is that in any uptrend, traders should be looking for reasons to be bearish rather than bullish. This might seem counterintuitive but the fact is that in any uptrend, by definition, most of the upside has already been seen. There is nothing wrong with being in a long position in an uptrend as long as all of the central criteria supporting that trend are still being met. But once we start to see evidence of stalling, risk-to-reward clearly starts to favor playing the downside. When we look at candlestick patterns, there are varying degrees for how this type of situation might play itself out. On one end, we have patterns like the Doji and Evening Stars mentioned above. On the other end of the spectrum, we have patterns like the Bearish Engulfing pattern, where a much more decisive move is being made (ie. the bearish pattern completely ”engulfs” the bullish candle that came before it). There are significant differences in the criteria that make up each of these patterns. But the main signals here are clear: the prior uptrend is starting to run out of steam, and the potential for reversal is becoming much more likely. The Dark Cloud Cover falls into this category, somewhere in the middle given the size of the reversal candle. Combining With Ichimoku Analysis Since the Dark Cloud Cover is a Japanese candlestick formation, it is not entirely uncommon to see the pattern paired with Ichimoku chart analysis. For this reason, it is a good idea to have some sense of when bearish Ichimoku signals are being sent. This way, it becomes easier to spot a confluence of events that support a reversal position. The Ichimoku Kinko Hyo is an indicator that looks much more complicated than it actually is. I am not going to cover all the basics in this article, as I have done this in another article. Here, we will be looking at the downward cross in the Chikou Span, as this is the indicator’s warning signal for lower prices going forward. This stance could be viewed as somewhat ironic because the Chikou Span component is actually a price plot that lags 26-periods behind the latest closing price on your chart: As far as general rules, prices are viewed as entering a downtrend when the Chikou Span is located below the closing prices on your chart’s candlestick bodies. In the chart above, this line is marked in green and we can see when the price activity starts to grow in downside momentum. This is the first indication that any bullish uptrend is likely to end, and signals like these become especially powerful when seen in conjunction with candlestick patterns like the Dark Cloud Cover. In this example, the Tenkan Sen starts to move lower while prices fall below the Kijun Sen. For technical traders, a situation like this marks a confluence of events that supports short positions. At the very least, it should be a warning signal to those holding long positions that the initial uptrend has run its course. Once a short position is established, Ichimoku analysis can also be useful for setting stop loss areas. Since this would be a sell scenario, the upper and lower lines in the Senkou Span should be viewed as primary and secondary resistance levels. If prices were to cross above these areas, it would usually be a good idea to close out the position. Conclusion: Candlestick Patterns and Ichimoku Analysis Can Be Used to Spot Reversals When we combine all of these ideas, it can become much easier to visualize situations where market momentum has reached an exhaustion point and an uptrend is ready to give back some of its gains -- if not complete in an all-out price reversal. This is mostly useful for those traders that are willing to push back against the majority of the market’s momentum and capitalize on situations where buying low and selling high is more feasible. No single indicator should be viewed in isolation and candlestick patterns are often combined with Ichimoku analysis as a means for identifying agreement in the available signals. The Dark Cloud Cover is one of the earliest indicators in this type of scenario. To spot this pattern, you will need to watch for individual candlestick formations as they are still unfolding. This takes a good degree of patience and specificity but if you are able to locate areas like these, there is a very good chance that you will be getting a jump on the rest of the market. The second part of the process is to confirm the validity of these patterns using an external indicator. When using the Ichimoku Kinko Hyo, remain cognizant of any crossovers in the Chikou Span. This could be your best signal that the “dark cloud” is actually a thunderstorm ready to end the previous uptrend.
  8. The Death Triangle: Looking at a Variation on the Head and Shoulders Pattern One of the biggest problems in the approaches generally taken by chartist traders is the tendency to over-rely on backtesting and simple probability figures at the expense of really looking at what price patterns are telling us about market sentiment. There is a reason, for example, that a Descending Triangle pattern is considered to be bearish, and there are clearly definable explanations for why short positions should be taken once the foundational support level in that pattern breaks. The same is true for flags, wedges, harmonic patterns, double or triple bottoms, etc. So what tends to get missed when we look at backtesting statistics (which give only limited information for how an asset is likely to trade in any given situation) is the underlying philosophy and rationale behind these patterns. It is important to remember that the the map is not the territory, the menu is not the meal. And there are many cases where traders might see markets unfold in ways that might not exactly match the textbook criteria for a specific pattern. One pattern that should be considered here is the Death Triangle, which uses some of the same rationale that is seen in a Head and Shoulders pattern. It is valuable to have some idea of how patterns like these inter-relate because it can be helpful in avoiding missed opportunities once they are present in the market. Head and Shoulders Structure First, let’s take a look at the commonly accepted structure for what a head and shoulders pattern should look like. There are some differences of opinion in which rules can be broken here but most traders would agree that the structure shown below would qualify: These structures take place in an uptrend, form a left shoulder, rally further (creating the head), and start to lose momentum until the neckline is finally broken. Stop losses could be placed above the right shoulder, and the profit target is generally located using a pip distance that is equal to the distance between the head and the upper price point found at the head. Above, we can see what the pattern might look more like in actual trading practice. Overall, the head and shoulder pattern is highly effective in pinpointing the ‘topping out’ period in a uptrend and can be used to short sell an asset. Structural Parameters But while this pattern is great for spotting these special circumstances, the reality is that markets don’t need to fit the textbook criteria. So, what happens if the shoulders are not equal? What happens is the neckline is not level? Is the structure still valid? Can short positions still be taken? The main point here is that waiting for textbook conditions will mean that you miss trading opportunities. Instead, it is much more important to look at the underlying rationale that delineates the pattern. What the head and shoulders pattern is meant to define is a topping structure, where the initially bullish momentum starts to give way until we start to see major support breaks. This means that the right and left shoulder do not need to be equal in order to be identified as a tradable scenario. In fact, there are instances where unequal shoulder levels will actually go further to match the rationale behind the pattern. The Lower Right Shoulder Specifically, consider the pattern with a lower right shoulder. Some traders might argue that this invalidates the pattern. But what is the real rationale that should be considered here? The main concept in the head and shoulders structure is that prices have reached a peak that they were not able to match again. A true uptrend is marked by a series of higher highs and lows. But when prices are only able to form a shoulder (and not a higher head) it essentially suggests that the market momentum is changing. But if the right shoulder is lower than the left, it is an indication of an even more forceful turn in momentum. This will only increase the probability for successful short positions as there is less of a reason to argue that the original uptrend is still in place. In a structure like this, we can see an example of how a trader that only obeys the textbook rules would have missed what is actually a much better trading opportunities. I am reminded here of the time when my football coach said that “the worst type of player is the one that never follows the coach’s rules -- but its also the one that does nothing but follow the coach’s rules.” The lesson here is that there will be plenty of instances where you will need to read the situation and identify times where the spirit of the pattern is being met even if the textbook criteria is not followed to the letter. The Death Triangle Another example here can be found in the Death Triangle, which is essentially a variation on the idea of the head and shoulders formation. Below, we can see the topping formation that begins after an uptrend and results in a major change in the market’s underlying momentum: In the above example, we can see price action that would be difficult to describe as a head and shoulders formation. But most of the important parts in the structure remain, and this is another structure that could be used to establish short positions in the asset. After the uptrend starts to turn, we see a pyramid-like structure that ends the previous series of higher highs and leads to a major support break. Sound familiar? It should, and this is because it is the same rationale that supports short positions taken once a head and shoulders is spotted. But if you chose to wait for three exact price levels that would fall into the commonly watched head and two equal shoulders, you would have missed out on the massive downtrend that was signaled by the ominous-sounding death triangle. In this pattern, we can see another example of how a commonly watched pattern should be viewed with some degree of flexibility. As long as you can still make a reasonable argument for lower prices, most of the same trading parameters can still be applied. Look to establish a profit target that is roughly the distance between the triangle base and the highest high in the formation. This is because prices tend to move in waves, and those waves tend to be similar (although not exactly similar) in value. Conclusion: Watch For Price Patterns But Don’t Restrict Yourself To Textbook Definitions In the example above, we can see that traders should not limit themselves to the textbook definitions when structuring new trades. This can lead to many missed trading opportunities and an imperfect understanding of how the market actually operates. The market will never obey the structural parameters in any pattern, as much as we would like to wish it would. Because of this, we need to allow some degree of flexibility and pay more attention to the rationale behind the pattern, rather than the pattern itself. This will open up your position to a much wider range of options and give you a better sense of what is actually happening in the market at any given time.
  9. Harmonic Trading: Terminal Bars and PRZ Failures When we look at most of the commonly employed techniques in technical analysis, one of the most striking things that comes to mind is the fact that there have not been many recent developments in the way day traders view price activity. Looking at the past research and market innovations in these areas, names like Gann, Wilder, Elliott, and Gartley quickly come to mind. But it is hard to ignore the fact that these names are relatively old and we have not seen many recent innovations in the underlying philosophies that mark modern technical analysis. This is most surprising because we have high-powered online trading stations that make this type of analysis much easier that it was 100 years ago (when technicians were literally plotting out their strategies with a pencil and a piece of graph paper). Harmonic Strategies One of the few exceptions to these troublesome trends (a large lack of innovation in TA strategies) is the work that has been done in Harmonic Trading. To less experienced traders, the Harmonic patterns might seem overly complicated and too much work in determining a regular trading strategy. But these patterns are really nothing more than a simple combination of Fibonacci retracements and extensions. So if you are familiar with these techniques (and most traders are), then harmonic trading should not be impossibly difficult to master. It can become difficult to remember all of the specific calculations for each pattern, and we have outline the parameters for all of the major patterns in previous articles. Specifically, details outlining the Bat, Crab, Butterfly and Gartley patterns can be found here. All of these patterns started with the Gartley pattern, which did not even use Fibonacci calculations as part of the structure. So, it is clear that traders have been looking for new ways to define these patterns since their inception. This is highly encouraging for technical analysis traders, as these types of strategies have several advantages that include high-probability directional indicators and tight reversal zones that allow traders to place stop losses very close to their initial trade entries. This can help immensely with risk-to-reward ratios, and give you a much bigger edge when trading in volatile markets. But modern traders can get lazy when using these patterns, as there are basically software indicators that do most of the work. These are very good indicators to use in active trading (for Metatrader, the plugin can be downloaded here). But it is very important to understand how the indicator works, and here we will look at two critical elements of the structures that must be understood in order to make Harmonic patterns work in your favor. These elements are the Potential Reversal Zone (PRZ) and the Terminal Bar (or T-Bar). Spotting Reversals with T-Bars The main purpose of using the Harmonic pattern is to spot trend reversals. If you are looking to trade in the main direction of the market -- and to capitalize on the majority price momentum -- then Harmonic patterns are NOT for you. Harmonic patterns are used as the basis for contrarian positions and are usually seen during periods of high market price volatility. If these types of conditions and strategies do not appeal to you, it is time to look elsewhere (perhaps at breakouts or range trading scenarios). But if you are a contrarian trader that looks for opportunities to ‘buy low, and sell high’ then harmonic patterns can be a fantastic addition to your trading arsenal. (Chart Source: CornerTrader) Visually, some of the earliest opportunities can be seen when a Terminal Bar (or T-Bar) forms on your chart. For example, an ideal bearish harmonic reversal should start with both the upper and lower levels in PRZ (explained below) have been tested. In the graphic example above, we can see that strong bullish momentum was violently rejected, resulting in a long upper wick and a quick break of short term support. If this occurs in an area where the previous price moves match the requirements for one of the Harmonic patterns (see the articles referenced above), then you have the criteria you need to make a trade entry. Bearish Bat Example Next, we look at a real-time example where the Harmonic leg requirements for the Bearish Bat pattern are met, and the ZUP trading plugin sends an alert (as it does for all Harmonic patterns). In this case, the Terminal Bar would only become invalidated if prices exceeded the 1.27 Fib extension of the move XA. Ideally, prices would drop after the Terminal Bar is formed, but there is also the possibility that prices could trade sideways without violating the pattern (as long as prices do not move beyond the 1.27 Fib retracement). Looking more closely at the Terminal Bar area, we can see the PRZ parameters being defined. This marks the entry point for a Harmonic Trade. The dashed line is the top of the Terminal Price Bar, and since this is a bearish pattern the area should be viewed as a level of critical resistance (if the pattern was bullish, the area would mark the key support zone). In cases where the T-Bar support/resistance level is broken, traders could actually flip the bias and trade in the direction of the original trend (as this would suggest that the original trend is still in place). Further work in some of these areas can be seen in the forex technical analysis section at ForexAbode. Failed Harmonic Reversals One of the benefits of the Harmonic pattern is its high level of success and accuracy. Most Harmonic patterns accurately depict the point of reversal in a strong trend, and this information can be very valuable for traders. But no price pattern -- no matter how well-defined -- is foolproof. And traders need to have strategies in place to decide what to do next when price patterns fail. (Chart Source: CornerTrader) In the graphic example above, we can see that prices have violated the PRZ and risen above the area market by the T-Bar. This means that the Harmonic pattern was never valid in the first place, and that the original trend is likely to continue. Aggressive traders could actually take the bullish position in a case like this. But for traders that are looking to employ Harmonic patterns exclusively, it is better to just wait on the sidelines. The philosophical tug-of-war in a situation like this would depend on whether you are looking to side with the market’s momentum or with the possibility of trend reversal. This is also a reason why many investors opt instead for options trading strategies when dealing with the financial markets. Those that side with the Harmonic argument would be in agreement that trades should be taken when prices have reached extremes (lows for longs, highs for shorts). In the chart graphic above, we can see prices reaching the 1.27 Fib extension of the price move XA. Given the strength of the move, it would not be ridiculous to start betting against the market in anticipation of a downside correction, if not a complete reversal in trend. But if traders had taken a bearish position, major warning signals should be received if prices continue higher. All short positions would need to be closed (as there is not real argument for high-probability short trades). Conclusion: Watch Your T-Bars To Decide When Harmonic Trades Should Be Closed Some traders refer to the T-Bar failure shown above as a Harmonic Breakout, as the forces that combine to structure the harmonic patterns have been overcome by the underlying momentum that is seen in the market. In traditional breakout trades, this is an argument to establish positions in the position of the break. In Harmonic situations, the probabilities for success are even higher, as there are more factors at work (not just simple support and resistance levels). In any case, the Terminal Bar can give traders a good deal of information in determining the validity of a Harmonic pattern that has shown on your price chart. For these reasons, it can be argued that the PRZ and T-Bar area is perhaps the most important area in the entire pattern. This applies in all cases, so the rules will still be the same no matter which Harmonic pattern you are watching on your chart.
  10. I am well aware of the fact that spreads can change when markets become more volatile. There are still many brokers that guarantee their spreads during these times.
  11. Hi, thanks for the article. I have written on a similar topic here: http://www.traderslaboratory.com/forums/forex/18608-trading-small-account-sizes.html#post193800
  12. Hi, thanks for the article. I have written on a similar topic here: http://www.traderslaboratory.com/forums/forex/18608-trading-small-account-sizes.html#post193800
  13. Hi, thanks for the article. I have written on a similar topic here: http://www.traderslaboratory.com/forums/forex/18608-trading-small-account-sizes.html#post193800
  14. Hi, thanks for the article. I have written on a similar topic here: http://www.traderslaboratory.com/forums/forex/18608-trading-small-account-sizes.html#post193800
  15. This is an interesting article but with a little research, traders can avoid these problems. There are many low spread brokers that guarantee their rates. Paying more than 1 pip for EUR/USD is ridiculous at this stage.
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