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Everything posted by RichardCox

  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.
  16. Trading With Small Account Sizes Now that regular forex trading activity has made its way into everyday households, retail traders have been able to enter the market with the ability to execute high leverage levels with very few limitations. But the unfortunate reality is that most forex traders are caught up in the hype and believe that quick riches are possible even when starting with the smallest account sizes. We have even started to see forex brokers offering micro accounts with minimum deposit sizes of $25 or less. This has democratized the trading environment but it has also made many traders with small account sizes vulnerable to quick market reversals that can wipe out an entire savings balance. For these reasons, it makes sense to assess the rules and tools smaller traders must utilize in order to stay in the game and keep their accounts growing. There are many market experts that will actually suggest there are no real differences when trading, and that a smaller account should be approached no differently than large institutional trading accounts. But while this is largely accurate, there are still some things that smaller traders must keep in mind in order to avoid a margin call situation that could deplete your entire trading account. Starting With Realistic Expectations The first problem that plagues most new traders is the problem of unrealistic expectations. This problem can take many different forms. But in most cases, you will see a new trader with a small account get a few successful trades in a row and then start to expect that those results will be duplicated forever. These traders will then start to do the math and figure out how much money can be made each day, week, month, or year. This is destructive, however, because it is taking your mind off of what you should actually be doing (analyzing the market and isolating high-probability opportunities) and centering it instead on scenarios that could make you rich with little effort. Markets are never this consistent, and there will be always be situations where you do better or worse than you have originally expected. Trading projections are generally not very useful (especially in the early stages) because there are going to be many events for which you are unprepared and many market scenarios that might not necessarily conform to your original trading plan. The unfortunate reality is that you are not going to be able to turn a $500 account into $1 million in a month or a year. Even if you max-out on your available leverage, these are unrealistic expectations that should be disregarded immediately if you plan on being an active trader for the long run. Large/Small Account Sizes: Similarities And Differences At the same time, markets are markets and trading is trading. The argument can be made that a $500 account should be traded no differently than a $1 million account (other than the fact that trade sizes should be proportionately smaller). There is a good deal of truth to this, because the probability for a given chart pattern will not change depending on the amount of money that is in your account. In these ways, large and small account sizes are essentially no different as long as you keep your risk percentages to appropriate levels. (Conventional wisdom here suggests that you should never risk more than 2% in any one position.) It is also important to remember the characteristics of the markets you are trading. One example would be differences in the ways gold prices vary relative to currencies. When viewing the market in this matter, the real issue is the strength of your strategy rather than the size or your position. The key here is to view your account in terms of percentages, rather than in Dollar figures. In other words, look to make back your 2% on the trade, rather than trying to make $100 or $1,000 on your trade. It is amazing how often this mistake is made, as traders start to look at the forex market as a source of income rather than as a living organism that does not care about whether you win or lose (or if you have made enough money to cover your monthly bills). It is also another reason why options trading strategies might even make more sense for new traders. Forex trading simply doesn't work like that and if you expect to stay in the game you will need to view your balance in terms of percentages rather than as a potential Dollar figure. Stop Losses and Market Anomalies Large accounts are better positioned and better able to weather market anomalies. As a personal example, I remember being short the EUR/CHF when the Swiss National Bank (SNB) decided to construct a price floor at 1.20. This was done to prevent excessive strength in the CHF but the move was largely unexpected and took many traders (myself included) by complete surprise. I was in front of my trading station when this occurred and I saw prices climb by more than a thousand pips in minutes. I did not have a stop loss in place when this move occurred and this created the biggest loss of my trading career. Fortunately, my position sizing in this case was relatively small and I was able to avoid the total depletion of my account. (Chart Source: CornerTrader) But what would have happened here if I was just getting started? Would I have been able to withstand the losses taken by such an unexpected move? Prior to that day, I never would have guessed that markets (especially the EUR/CHF, traditionally a low-volatility forex pair) could move 1,000 pips in a day -- in any direction. Of course, I was wrong in this case and the mistake turned out to be very costly. For these reasons, stop loss placement is much more important for those with small account sizes as there is much less flexibility and margin for error. The market can (and eventually will) surprise you and destroy your expectations. For those with small trading accounts, proper preparation here (a stop loss) is vital and could potentially be the only thing that keeps your account active when a market anomaly occurs. Conclusion: Does Size Matter? So here we come to the ultimate question: Does account size matter? Unfortunately, the answer is a vague ‘yes and no.’ “Having a small account size means that you will absolutely need to take certain precautionary measures (ie. having a relatively conservative stop loss that is in place),” said Sam Kikla, markets analyst at BestCredit. “This is the only way to protect your account from market anomalies that can erase all of your previous gains in short order.” Another factor to remember is that leverage is much more dangerous when your account size is small. There is absolutely no reason a trader with a $500 account should ever be taking 200:1 leverage. At this rate, it would only take a small string of losses to completely eliminate your ability to continue trading. On the plus side, smaller traders that obey these rules (and focus on percentages rather than Dollar figures) will have access to the same returns as those with institutional accounts (again, in percentage terms). The real issue here is whether or not you are taking an overly aggressive approach to your trades. This is not a viable option for those with smaller account sizes. So, there are important differences that can put smaller traders in a more difficult positions. The positive here is that most of these difficulties are removed when you keep a conservative trading approach, use active stop losses, and structure your trades so that they are working as a percentage of the whole.
  17. Candlestick Trading: What Do Wicks Tell Us? As regular day trading in the forex markets moves onto personal PC platforms, we have also seen an upsurge in the number of people interested in technical price analysis. This has changed the way large percentages of the investment community view their positions. But what might be most ironic is that most of these changes were similar for most people. For example, there are many types of charts that can be used to conduct technical analysis but the vast majority utilize the candlestick chart. This is generally because these are the charts that give you the most information at a glance. The first graphic shows the basic structure of the bullish and bearish candlestick. Instantly, we can see the open, close, high, and low for each time interval and also determine whether or not the price action during that period was positive or negative. All this information might be much more useful for those with short term trading strategies (ie. after news releases), as these will often require you to make snap decisions with much more volatile conditions in place. Additional resources on candlestick analysis can be found here and here. Wicks Marking Extreme Highs and Lows The basics of candlesticks are easy to grasp but day traders often tend to overlook the nuances that are present in the representation of each interval. Candlesticks give us implied information that comes in addition to the simple readings of high, low, opening, and closing prices. Candles are able to give us significant clues about the validity of the underlying trend, the sustainability of momentum, and the general level of sentiment that is present in the market at any given time. Candlestick patterns such as the Doji, for example, can indicate that market trends have reached an exhaustion point and are unlikely to continue. In contrast, a Bullish Engulfing pattern might signal that an uptrend is still running along smoothly and still has the capability to reach new highs. This is important information that can not be seen in price charts that show only the opening or closing prices. So, while it would be impossible to go over all the nuances of the candlestick viewpoint, it should suffice to say that we are viewing much more than simply price activity when we are looking at these types of charts. Specifically, we are able to use these tools to assess broader sentiment and the likelihood that prices will be able to continue moving in their present direction. Some of the better analysis I have seen in these areas been written by the ForexAbode daily market analysis. Here, you can find more resources on their daily forex strategy. Supply and Demand Any approach to technical analysis should first start with the understanding that supply and demand is what governs markets. When an asset starts to fail at a key resistance point, it is an indication that there is too much supply to sustain prices at their current levels. When prices bounce off of a support level, it is an indication that there is too much demand to keep prices low. But most important for our discussion here is that these types of moves tend to happen quickly. (Chart Source: Orbex) In the CAD/JPY chart graphic above, we can see instance where strong supply or demand has started to change the structural trends seen in the market. Failures at resistance and bounces from support are usually seen when prices have made extreme deviations from their historical averages. This is the activity that creates the ‘wicks’ in candlestick trading. Since these moves tend to happen quickly, prices generally rise or fall too quickly to hold at those levels as the interval is closing. So, wicks essentially show you the market’s rejection points -- the points at which the market has decided there is too much supply/demand relative to the current price level. Trend Characteristics Another point to remember is that trends themselves have their own ‘trends.’ That is to say, there are common characteristics that be identified in the majority of the market’s trending moves. Momentum builds to a peak and then reaches an exhaustion point. The exhaustion point is the end of each wick, and candlesticks can help us to quickly visualize the present stage of the current trend moves you are watching. When a wick forms on one of the longer term time frames (ie. the weekly or monthly charts) it is a strong indication that sentiment has turned, and this is often an early sign of trend reversal. Traders that are able to identify these events as they occur will then have the opportunity to ‘buy low, and sell high.’ In most cases, this is where the best opportunities for low-risk entry points can be found. This is one of the best strengths of technical analysis as traders well-positioned with an understanding of these concepts are usually able to spot changes in market supply and demand much more quickly than the traders that are relying on a fundamental basis for their trading ideas. Here, traders can find additional resources for managing risk in forex trading, and this is important given the fact that price wicks tend to be associated with heightened volatility in the forex markets. Validating Support Turned Resistance Additionally, candle wicks can be used to validate situations where support is turned to resistance, and resistance is turned into support. In many cases, support will start to act as resistance (and vice versa) once the level is overcome and it is highly common to see wick develop when these market events occur. It is also common to see ‘blow-off’ tops and bottoms where the wicks will briefly pierce a support or resistance level -- only to quickly reverse and catch traders in a false breakout scenario. These events can be costly, to say the least. So here, candle wicks can actually give us an indication of what NOT to do (ie. buy or sell a breakout if we do not see the time interval close above or below the support/resistance level you are watching. In the second support/resistance chart, we can see how these events might unfold when trend lines are used as the support and resistance zones. These situations might look different than range scenarios with horizontal lines of support and resistance -- but the rules for each situation remain relatively similar. Conclusion: Watch For Wicks Before Making Trade Entry Decisions It can be easy to dismiss candle wicks as an irrelevant part of the trading equation and focus instead on the price action seen in body of the chart candle. Some might argue that this is the most important (and relevant) area to watch because this is where prices are stuck most of the time. But while the candle body might be a better indication of the true price of an asset, this is not going to be where the best trading opportunities rest as most of the extreme moves have already been seen once prices revert back to these areas. Trade entries that are based on candle wicks have the potential to include much better risk-to-reward scenarios as they deviate from the ‘true’ price of the asset. So, when we look at wicks, it is important to start positioning for possible reversals as sentiment starts to change with respect to the broader trend. Conversely, wicks can also be used as a means for validating support turned resistance levels. Activity here can actually be used to show that a bullish or bearish trend is still in place so there are many different ways to view what is happening in the markets when price wicks occur. because of this, it is always a good idea to look at chart formations in the context of the broader market rather than looking at them in isolation. Nothing in forex trading happens in a vacuum, but price wicks give traders a lot of important information that is often overlooked by people that are not closely watching their charts. Avoid these mistakes, and you will be in the position to make higher probability strategies for entering into your positions.
  18. I just finished an article on this topic here: http://www.traderslaboratory.com/forums/forex/18483-fibonacci-trade-scaling.html
  19. I just finished an article on this topic here: http://www.traderslaboratory.com/forums/forex/18483-fibonacci-trade-scaling.html
  20. I just finished an article on this topic here: http://www.traderslaboratory.com/forums/forex/18483-fibonacci-trade-scaling.html
  21. Fibonacci and Trade Scaling When I first started trading I was losing in most of my positions – as everyone does. I started trading with no real strategy and whatever activity I was conducting should be described more as gambling than as trading. This is because there was no real ‘rhyme or reason’ to my approach and since I was randomly selecting assets to buy or sell, I had no better chance than guessing a coin flip on any given occasion. Of course, many lessons followed and a good deal of those had to do with the technical analysis techniques I have written about in the Forex column of this website. But not everything comes down to mathematical probabilities, and there is a good deal of ‘common sense’ that is employed by every successful trader. One example of this can be seen in the fact that it is essentially impossible to consistently nail down the perfect trade entry. It is possible to get lucky now and then – even a stopped clock is right twice a day. But expecting to do this with any consistency is totally unrealistic and should not even be viewed as an approachable goal. Does this mean that traders should feel hopeless when making the decision to pull the trigger on a trade? Not at all. Separating Your Trade Entries The first mistake that many traders make is to place an entire position stake in a single location. For example, you are bullish on the Euro and you decide to buy the EUR/USD at 1.35. At best, these novice traders will at least follow the conventional wisdom and never enter into a position that puts more than 2% of your total account at risk. But this is not nearly enough trade planning as it still suggests that the trader had entered into the position at the exact right time and place. Since this is almost never the case, more work needs to be done in the planning stages – before any orders are executed. Specifically, this means separating your positions into multiple parts. “The easiest way to scale into positions if doing to divide your trade size in twos or threes,” said Tony Davis, head trader at Atlanta Gold and Coin. “and then to find two or three places on your chart where price activity is likely to work in your favor (i.e. clearly defined support or resistance levels).” Risks I first realized that this was a preferable approach during a GBP/JPY trade, which as you might know is one of the more volatile forex pairs. At this stage, I was mostly looking for trades that risked about 125-150 pips but I quickly learned that this was an unrealistic expectation for this low-liquidity pair, which is capable of significant intraday moves. In this case, I quickly found my position in negative territory, down -150 pips, and I had to make a decision because I was starting to exceed my previous risk threshold. Some traders argue that you should never deviate from your original game plan, but I could never totally agree with that. Instead, I chose to double my position, and improve on my average price. In this case, the trade did rebound in my favor and I was able to close out at a profit. Some experienced traders would argue that the above approach was a bad idea – and in some ways they are correct. I did break my original trading rules and expose myself to double the losses in a market that was already working against me. But I think the most valuable lesson for me in this case was that establishing your entire position in the same location (the same price level), is one of the biggest mistakes that a trader can make. Does that mean I should have doubled my position in the above scenario? No. It means that I should have divided my position in half (or in thirds, fourths, etc), and then scaled into the position once the market started working against me. Of course, this means that your regular trading activities are going to become much more complicated. You cannot simply find a support or resistance level and then place your entire order in that area. Instead, you will need to find two or three (or more) separate entries and actively expect that the market is going to start working against you. Could the market immediately turn in your favor? Of course, and in this case you would not be trading at a full position size (which also means reduced profits). But what is most important here is to adequately manage risk and protect yourself from unnecessary losses. This benefit outweighs even the more substantial profits that would have been realized if you had staked your entire position and the market immediately started to work in your favor. The reason for this comes from the fact that the favorable scenario is far less likely, and will happen much less often when compared to situations where your initial trade entry was ‘less than perfect.’ Possible Strategies (Chart Source: Orbex) The next question you should be asking yourself here is: How can I find multiple entry points for a single trade? There are many ways of doing this. Even the simplest technical analysis strategies will generally outline more than one support or resistance level on any given chart, and these can be used to define price areas that that agree with your original strategy. For example, in the chart above, we can see relatively clear historical resistance levels in the Euro at 1.37 and just above 1.38. Many charts will have more than two support or resistance lines drawn. So hypothetically, there would be nothing wrong with establishing half a short position once prices reach 1.37 and then wait to add on the second half if prices continue higher into the 1.38s. This would give you an average position size of roughly 1.3760, rather than your original 1.37. When you have live positions, this added trade cushioning can make a significant difference if things start to work out unfavorably. But what is even more important here is the fact that prices would have had to break all of your original prices and the next one in order to stop you out. Moves like this are relatively unlikely, and these types of market tendencies are outlined in these courses to learn finance online. This is one way that traders can turn the probabilities in their own favor, and this is a strategy approach that should be applied in almost all cases. Fibonacci Fibonacci studies offer another possibility. But what is most important to remember with Fibonacci is that the numbers should be viewed as approximations. Many traders claim to base positions on the ‘cosmic nature’ of the Fibonacci sequence (the Golden Ratio). The financial markets are just another organism in the universe, why wouldn't they follow the rules of physics that every other entity must follow (tree branches, shell shapes, hurricanes, etc.). Not all of us subscribe to these types of ideas and not all us us feel the need to define a retracement by its relationship to the 38.2% or 61.8% Fib level. Instead, I am interested in what is happening to the price at any given moment. Is something likely to happen in this asset? Right now? If not, move on to the next chart. If so, start looking at how a trade could be positioned. It is just as acceptable to view these retracements in thirds, so instead of the 38.2% retracement, you are viewing the market as having had a one-third retracement of its original move. Let’s say your criteria are met. In order to use Fibonacci, you need to identify a predetermined price move. This is easier said than done because there are a lot of prices moves on a price chart. Everything that happens on a price chart is a price move. Fibonacci Example Not enough space here to get into how to define a retracement move. I have explained Fibonacci in depth here in other articles (for example, here and here). The graphic below shows how you should be looking at when using Fibonacci to scale into a position. (Chart Source: Orbex) In the chart above, we can see clearly defined Fib resistance at 1.3770 (38.2% retracement), at 1.3820 ( the 50% retracement), and at 1.3860 (the 61.8% retracement). Traders looking to enter into bearish positions could place one short entry at each of these levels (a third in each position), with a stop above the two-thirds retracement of the original decline. This would allow you to scale into your position and protect against major upside risk while using the Fibonacci retracement.
  22. Hurst Cycle Analysis An American aerospace engineer, J.M Hurst was one of the first people to use computer technology to plot and analyze the cyclical behaviors that can be found in the financial markets. This occurred as early as the 1960s, and shortly after he published The Profit Magic of Stock Transaction Timing, where the introduced the theories that would eventually form the basis for what we now call the Hurst Cycle. Hurst’s approach to the market rests on the idea that multiple cycles act in concert as price and time moves forward in the financial markets. Hurt’s explanations stopped short of what actually cause these cycles, but he still believed these occurrences could be understood in ways that would allow traders to profit from them. Hurst’s studies included more than 1,000 different asset types, as he sought to understand the nature of price changes rather than to attempt cornering any single market. Summary of Concepts The mathematics behind Hurst’s approach can be difficult to understand, but the main points can be summarized here: ● The financial markets behave in a cyclical fashion. ● There is a set of number recurring cycles that range from short to long time intervals. This cyclical set is referred to as the Nominal Model (shown in the first table below). ● Market cycles are harmonic, and relate with other by factors of two or three ● Cycles build on each other, creating larger composite cycles. This is also referred to as the principle of Summation. ● Longer cycles generate larger changes in price. Hurst referred to this as the principle of Proportionality. ● Lows for the cycle unfold quickly when short composite cycles create troughs in the same region. This is also referred to as Synchronicity. ● Cyclical peaks will often appear rounded, whereas troughs are usually sharper. ● Variations in cycle length will occur, but market cycles always revert back to their averages. Harmonic Ratios and Cycle Periods One of Hurst’s central discoveries was that market cycles are not random in terms of periodic wavelength. Instead, the prominent wavelengths are related by a harmonic ratio (factors of two or three). According to Hurst, these wavelengths are recurring and can be applied to all markets. These wavelengths can be divided in terms of time and can be found in the table below: The time periods stretch from 5 days to 18 years. In the table above, we can see that there is the potential for variation within each wavelength. But these variations will be minimal and will always revert back to their averages. Hurst also found that the market’s dominant cycles will have synchronized troughs but not synchronized peaks. This is a critical element of the Hurst cycle analysis as it allows traders to project the size of the wavelengths that will follow. Ultimately, the underlying trend can be defined as the motive effect of the longer term cycle, relative to the shorter term cycle you are trading. Trading in the direction of the broader cycle can help to improve positioning probabilities. Analyzing Sentiment The central idea behind Hurst’s cycles is that nature tends to move in a predictable rhythm. For example, night and day changes at the same rate, and the seasons follow one another in a fashion that can be anticipated. These expectations can be applied to the financial markets, as well. Optimism and pessimism unfold in cyclical ways, first tentatively and then with greater force as more of the market starts to accept the changing reality. These trends (price movements) then reach a point of exhaustion, traders realize that prices have deviated too far from their historical average, and then the trend starts to reverse. This, of course, is a simplified view of market activity. But most sentiment behavior follows along these lines and, as a result, should not be viewed as random. In any given moment, there can be a variety of sentiment cycles acting at once. Short term trends might be bearish while medium or long term trends are bullish. Everything comes down to the current cycle and the peripheral cycle that most directly influences it. Hurst Cycles Peaks, Troughs, and Wavelengths In some cases, price cycles will be clear and obvious. In other cases, they won’t. To some, this might suggest that trading with cycles is unreliable. But when the right tools are applied, these types of strategies can start to show much better results. The black line in the chart graphic below shows a cycle starts by falling to a trough at point A. The cycle then turns positive through point B and rises to a peak at point C. A similar movement follows, only in reverse -- falling back through point D and than to another trough at point E. As a point of illustration, let’s assume that points A and E represent the same price level. In this case, the distance between points A and E would represent the length (or time period) of the cycle. We can also see the distance from the peak to the trough as the cyclical amplitude. The longer the wavelength, the more power present in the cycle. For example, a one-month cycle will generate larger price moves then a one-week cycle. In the chart example below, we can see how Hurst cycles might look on a bullish swing move: Hurst’s “Valid” Trend Lines Trend lines can be a great tool because of the way they allow traders to bring visual order to the underlying price activity. But Hurst argued that most trend lines are subjective, and that we should instead view price action as a composite of cycles (of differing magnitude). All cycles (shortest to longest) form the composite and define the net effect of the trend (positive or negative). For example, if the Hurst cycles are advancing together, then the long term trend is bullish. This would ultimately meant that the short term Hurst cycles would produce troughs that are successively higher. The chart graphic above shows a cycle with an underlying trend that is essentially flat. If we were to draw a line connecting the adjacent lows into the future, the result would be horizontal. This line could also be viewed as a support line, as it would attract most of the price activity. But if the longer term cycle is pointed upward, the same action of connecting the troughs would result in an upward trend line where bullish positions could be taken. Hurst argues that these trend lines are objective (i.e. “valid”) because they are based on a clear rule -- connecting the cyclical troughs. These Valid Trend Lines (or VTLs) can also be used in reverse. Any time these formations are broken, it is a signal that the longer trend cycle has reached its conclusion. This information is useful because it gives us an objective trend reading and better insights into the magnitude of the potential reversal. The Future Line of Demarcation (FLD) In conjunction, Hurst also introduced his Future Line of Demarcation, or FLD. Conceptually, the FLD is a bit more complicated. But it is essentially the original Hurst cycle displaced, one-half of the cycle’s period to the right. In the chart below, the FLD is shown as the faint black line. The darker blue line is the Hurst cycle: As you can see, the FLD is simply a copy of the cycle, moved to the right by half the cycle wavelength. If you cycle is 180 days, you would plot the FLD 90 days to the right. The FLD tells us three things: ● Confirmation of a previous peak or trough ● An indication of future price direction ● The magnitude of the following move In the chart below, these three points are outlined: Here, we can see that when the FLD crosses below the Hurst cycle (green circle), the peak of the cycle is confirmed. When the FLD crosses above the Hurst cycle (green circle), the trough of the cycle is confirmed. The following price movement will continue in the direction of the crossover (purple arrows), and the magnitude of the movement that followed will be equal to that of the previous cycle (measured here using the orange line). All of these factors tell us when a Hurst cycle is changing, how far prices are likely to move, and in which direction they are likely to travel. A good way of interpreting the FLD is to assume that the Hurst cycle will peak as the FLD makes a trough, and vice versa. Conclusion: Hurst Cycles Help Define the Predictable Nature of Market Sentiment Hurst’s work might seem complicated at first. But when we look at the underlying reasoning, it merely attempts to describe the predictable nature of market sentiment. There are a variety of platform tools that can be used to express these changes, and most of these tools are best used when traders are looking to define the probabilities for trend continuation or reversal.
  23. Understanding the Kairi Relative Index When deciding on which chart indicators to use, technical analysts will often come from one of two schools. There are those that use indicators employed by the majority, as this will give a sense of what most traders are likely to do next. But there are also traders that look to utilize indicator tools that are not as well known. The argument here is that less commonly used indicators can send signals that might not be visible to most market participants. Both approaches have their advantages. But it is always a good idea to have at least some idea of how to use the lesser known indicators so that you can understand the analysis of other traders and capitalize on opportunities when they emerge. The Kairi Relative Index Defined Most traders that base trades on price action and technical analysis will almost inevitably come across the Relative Strength Index (RSI), which was developed by market guru J. Welles Wilder. This commonly used charting tool is generally used to get a sense of when prices have become overbought or oversold. A lesser known tool that in some ways bears a resemblance to the RSI is the Kairi Relative Index (KRI), which originated in Japan but was developed by an unknown trader. The word “kairi” means “separation,” which is appropriate given the way it is used to identify the underlying relationships found in trending markets. Considered both an oscillator and a leading indicator, the Index plots the deviation of the current price relative to its simple moving average (SMA). This deviation is then given as a percentage of that moving average. When these deviations show that trends are overextended, contrarian positions can be taken based on the potential for reversals. This means sell positions in an uptrend, or buy positions in a downtrend. This is the formula for the KRI calculations: Here, SMA refers to the Simple Moving Average. N refers to the number of time intervals used in the SMA (default is usually 14 periods). Plotted visually, the KRI looks like this: Comparisons to RSI The RSI and KRI are clearly individual indicators, with varied differences. But the best way to understand the inner workings of the KRI is to view it in comparison with the widely understood RSI. As momentum oscillators, these tools measure the rate of change in market prices. When prices rise, momentum is increasing. Once those gains start to falter and decline, that momentum drops. The values in both the RSI and KRI change as markets fluctuate but since the calculations in both tools vary, their readings will send different signals. In the chart below, we can compare the readings on both indicators relative to the same price action: The comparisons here in the overall trajectory should be clear. But when we look at the KRI, it can be argued that the signals are more clear, given the slightly more extreme nature of the plotted fluctuations. In this way, the KRI can be described as more of a moving target indicator. Oversold and Overbought Regions But what we are really looking for in the chart above is evidence that prices have either become oversold or overbought. In the chart below, we can see overbought price action as the indicator reaches the top of its range. Oversold price action can be seen as the indicator reaches the bottom of its range. Indicator Divergences In previous articles, I have outlined some of the characteristics of divergences and hidden divergences. The KRI can be used to identify these market events, as well. When price action and the KRI show divergences, buy and sell signals can be signalled. If prices are making new lows and the KRI is NOT making new lows at the same time, a bullish divergence is in place and buy positions can be established. If prices are making new highs and the KRI is NOT making new highs at the same time, a bearish divergence is in place and sell positions can be established. The chart graphic below shows an example of a bullish divergence: The next chart graphic shows an example of a bearish divergence: Crossovers and the Centerline The KRI will also send signals to buy and sell when prices cross above and below the zero line. When prices cross the zero line from above, a sell signal is given. When prices cross the zero line from below, a buy signal is given. Examples can be seen in the chart below: Comparative Calculations When looking at the KRI calculations (the deviation of prices from its SMA, shown as a percentage), you will be looking to sell the asset when the percentage is high and positive. When the percentage is high and negative, it is time to buy. When we look at the calculations of the RSI, we see numbers that are based on closing periods and whether those periods close up or down. This is the formula for the RSI: Here, RS is the average gain over the average loss, and is the reason the RSI is categorized as an oscillator. In non-mathematical terms, this formula essentially describes where prices have been and the likelihood prices will continue in the same direction. Both the RSI and KRI use a default 14-period setting for their SMAs. If you are looking for a response to markets that is faster, the indicators can be customized to use fewer periods. Slower signals tend to be more accurate but produce fewer signals. For this, you will need to set your periods higher than 14. Center Lines “The RSI and KRI are both categorized as center line oscillators, which means that the center line is of primary importance,” said Vlad Karpel, options strategist at TradeSpoon. “This is the area that determines whether you should exit or enter a trade, and whether your position should be short or long.” The center line can also help you to determine whether the dominant market condition is a trend or a range. In the RSI, traders will generally go short when the RSI rolls over from above 70 and go long when the indicator rolls up from below 30. Potential drawbacks are seen here if prices remain above 70 or below 30 for extended periods of time. In contrast, the KRI attempts to signal market reversals in their early stages or to produce signals when prices diverge from indicator activity. In the RSI, the center line is 50. In the KRI, the center line is zero. On average, the KRI is equal to roughly 500 pips from the center line to the top of its range. It is also 500 pips from the center line to its range bottom. This is slightly less than the 600 average that is seen in the RSI. Conclusion: The KRI and RSI Pose Subtle But Important Differences For technical traders that are looking for a new spin on the commonly used indicators, the KRI is one option that should be considered. Many traders are already familiar with the inner workings of the RSI indicator, so it is not a significant step to make the leap and test out the KRI, as well. There are advantage and drawbacks in both cases but if you are looking for ways to gain a different perspective on what the majority of the market is doing at any given moment, the KRI presents a viable option for an alternative indicator choice. Trades can be based on a variety of signal types -- divergences, center line crossovers, or evidence that markets have strayed too far from their moving averages (overbought or oversold conditions). This variety of signals offers traders a large number of tools that can be used when looking to construct new trade ideas.
  24. Advanced Price Patterns: Gann’s Law of Vibration The work of W.D. Gann tends to generate mixed responses from traders. These reactions range from outright dismissals to loyal enthusiasm for each of his methods and perspectives. But traders on either side of the fence find it difficult to disagree with the fact that the work of W.D. Gann forms the basis of many commonly use trading approaches in technical analysis. In order to understand Gann’s methods for approaching the financial markets, we must first understand his Law of Vibration, which the introduced in his book, The Tunnel Thru The Air. It can be said that Gann was not the originator of many of the central ideas presented in the book. In fact, Gann himself paid extensive homage to the Christian Bible, specifically citing St. Matthew's Gospel, chapter 12. Religion aside, it is clear that Gann was inspired by St. Matthew’s use of of the gematria -- the ancient science of numbers. So, the foundations of Gann’s approach to the financial markets (the pattern behind the Law of Vibration) extends back more than 1,900 years. But it seems impossible to draw connections between ancient science and modern markets. How exactly does this Gann’s Law operate? What was Gann’s purpose in devising an alternative view of the financial markets. The Work of George Gurdjieff The easiest way of understanding Gann’s approach can be found in the work of George Gurdjieff, which used a simplified approach of the pattern behind the Law of Vibration. Gurdjieff worked from Gann’s focus on the cyclical nature of the markets and looked to benefit from its inner workings during active trades. The idea is that collective market behavior exhibits cyclical activity. These types of terms are also commonly used in Elliott Wave analysis. But, with Gann (and with Gurdjieff’s simplifications), a very different type of structure unfolds. Key differences between Elliott and Gann can be seen in the alternative approach to trends. Many traders would like to believe that Elliott Wave theory is the most accurate way of quantitatively analyzing sentiment in the markets. But when we look at Gann’s approach, we can see a much more realistic representation of the way market participants react to new information and sources of data. Pattern Structure The chart graphic below shows the pattern behind the Law of Vibration, and there some important differences between Gann’s model and the traditional “sine-wave” models that are employed by cycle analysts. In Gann’s model, we can see a much more erratic representation of the market’s reaction to new information. This model does away with the robotic sine-wave structure that defines many cyclical price models. Like it or hate it, Gann’s model much more accurately represents the irrational exuberance that is often found in the market, and the over-extended price corrections that are seen when the reality sets in. Let’s assume that new information presented to the markets is positive for asset prices. When the cycle is separated into a 1-2-3-A-B-C format, an initial bull move is generated by the positive shock of new information. Prices run ahead of economic fundamentals and short term traders take profits, creating a corrective retracement to the downside -- the breakdown phase. This creates an “energy gap” and prices than fall to point A. But since the news was positive, it is unlikely that prices will fall below the price area that marked the beginning of the cycle. The real price move then begins, as traders “apply” the new information and generalized sentiment improves. Once these rallies become over-stressed, a much larger breakdown occurs as the system remains unchanged. Markets then show a more subdued recovery, with the overall trajectory in-line with the direction of the new information that started the cycle. A more real-time example of what this cycle looks like can be found in the graphic below. Pattern Interpretations So, while some technical analysts dismiss Gann’s work as being overly esoteric, a more simplified interpretation can be seen in the market’s predictable response to new data. As investors absorb new information, cyclical phase activity can be anticipated. These price waves can be used as a reason to scale-in and scale-out of positions, enabling traders to capture a much larger portion of the trend (when compared to those that simply “buy and hold” in trading). As the cycle progresses, price moves tend to be less extreme (i.e. volatility slows) as the system has already absorbed the initial shock and the market majority has already responded to the new information that began the cycle. In this way, Gann’s Law of Vibration provides market insights into the ways the majority reacts and shows cyclical behaviors. In time, the system (and the cycle) will run out of energy and market participants will need a new impulse event to generate major changes in sentiment. Shock, Reversal, Recovery One of the difficulties when using Gann’s model is that it is highly subjective in nature and there are no exact price points that mark the cyclical structure. But while this might discourage some traders from seeing validity in the model, it should be remembered that the same types of criticism can be applied to Elliott wave analysis -- an approach that has gained widespread acceptance in recent years. The best way to approach Gann’s model is with a broad view, and see it in terms of the market behaviors it looks to describe. The initial activity is propelled by a new piece of market information. This, for example, can come in the form of a major piece of economic data or a geopolitical event. Prices than move in the direction of the data (positive or negative), but markets tend to overreact and push prices to an irrational extreme. This leads to a significant reversal, as investors that entered the move too late are now forced to exit their trades. This completes the initial impulse phase of the cycle (moves 1-2-3 shown above). The recovery phase then begins and prices begin a more subdued move in the direction of the original impulse. This move also unfolds in three waves (the A-B-C structure shown above). Percentage Moves Last, the Gann model tends to give approximate time zones for when each wave is likely to unfold. This should not be surprising to those that are familiar with Gann’s work, as most of it focuses on the relationships between price and time. In the chart below, we can see each wave as it relates to a percentage of the entire cycle: The graphic shows each sub-cycle as it relates to the whole. For example, the first price correction (Point 2) tends to unfold near the 25% mark. This percentage framework can be useful for those that are looking to place real trades using the Gann model, as it helps give a better indication of where in time price reversals and continuations are likely to take place. Conclusion: View Gann’s Model as a Representation of Market Behavior There are many traders that actively dismiss the work and models put forward by Gann because of their subjective nature. But it should be remembered that most (if not all) approaches to technical analysis are subject to the same criticism. It is best to view Gann’s model in terms of its representation of market behavior, as there is a good deal of accuracy here in describing human activity in the markets. The underlying pattern in Gann’s Law of Vibration is not always easy to spot. But when we look at the basic structure (information shock, price reversal, trend recovery) along with the expected percentage values in the total cycle, the pattern can start to become visible more quickly.
  25. 3 Peaks and the Domed House When markets are showing a strong uptrend, contrarian traders will generally be looking for opportunities to identify reversals and establish short positions. When traders are first starting out, some of the methods for accomplishing this might include an oversold reading on the Relative Strength Index (RSI), or a failure at a closely watched region of historical resistance. Trades based off of more complicated structures, however, can yield better results as you will need to see a larger number of elements acting in agreement with one another. One example here includes the 3-Peaks and Domed House pattern, which is more complex and relatively unique in that it combines multiple patterns into one. The advantages of this patterns can be seen in its ability to pick tops in an uptrend and to project the magnitude of the downside moves that are likely to follow. Ideal Example First, we look at the general structure of these topping patterns to make them easier to identify once encountered. These price intervals and relationships would mark an ideal formation. In real-time trading there can be variations but the overall shape and price points will need to be present in order for the patterns to be valid. If price points are missing or the structure is out of proportion, trading positions should be avoided as the pattern would be invalid. Here is the ideal structure: As you can see, the 3 Peaks and Domed House pattern requires the formation of two separate price shapes: an initial structure with three price peaks, and than this is followed by another structure that can be described as looking similar to a domed house. Next, we will break down these two components: The 3-Peaks Structure: Starts at Points 1-2 which form a base Sharp rise in prices occurs to Point 3 Points 3-7 make the “three peaks” Price than drops in three unfolding waves, falling to Point 10 The Domed House Structure: The second base starts with a rebound from Point 10 The rally is composed of two corrective waves that run through Points 11-14 (without this double-correction, the beginning of the Domed House structure is not valid) The left “wall” of the House is formed by the price rally to Point 15 This is than followed by a sideways movement (the “roof” for the “first floor” of the House) that runs from Point 15 to Point 20 Prices then rise to Point 21, forming the “left shoulder” of what will become a Head and Shoulders pattern through Point 25 Point 23 marks the highest price point at the “head” of the short term Head and Shoulders pattern (can also be thought of as the top of the Dome, or the “roof” on the “second floor” of the House) Right “shoulder” forms at Point 25 A sharp drop then follows through Point 26 and Point 28, in a move that forms the right “wall” of the Domed House Projected moves for the decline to Point 28 can be found at the price equivalent to Point 10 Time Frames When we see a 3-Peaks and Domed House pattern unfold, it is important that the normal completion time can take longer than most of the price patterns that are commonly used in technical analysis. This is because most of the traditional price patterns are singular in nature, and our pattern here does not follow that limitation. For example, if we are using a daily chart, the 3-Peak element would generally take around eight months to complete. The Domed House portion of the pattern would generally require around seven months to complete. So it is important to remember that these types of patterns require patience in order to make sure that all of the required elements are actually in place. Of course, this pattern is not solely visible on the daily charts, and any time frame can be used when basing positions on these events. But what is most important is that each corrective wave unfolds in its proper place and that the structure is appropriately proportioned. Reverse Variation Technician George Lindsay is widely accredited with discovering the presence of this pattern but the introduced an additional variation, as well. Specifically, this means that the 3-Peaks portion of the structure does not necessarily have to precede the Domed House. As such, the ideal Domed House and 3-Peaks pattern would look like this: In this variation, you will notice that there are no significant changes to the generalized price moves other than the fact that the Dome comes first. It is important to note, however, that Point 1 and Point 28 are marked at the same price level. When determining your price target, your projection comes at Point 10, which will be equal to Point 28/1. Real-Time Examples Ideal examples are great for understanding what a broad structure is “supposed” to look like. But when we are actively trading, this might not work out perfectly and this can make certain structures more difficult to visualize and identify. Here, we will look at a real-time example of the trade at work. This example uses the more traditional structure, where the 3-Peaks portion of the pattern comes first. In the example above, we can see the initial 3-Peaks unfold at Points 3,5, and 7. All three Points forming at the same level would be an extremely rare occurrence (especially in light of the following structures), so some leeway and flexibility needs to be given. What is most important is the number of corrective wave structures and the overall proportionality of both pattern elements. This does occur in the initial structures and we have now reached Point 23, which is the highest peak of the entire pattern. Traders should now be alert to potential shorting opportunities, and sell trades can be taken after prices break the neckline of the short term Head and Shoulders pattern. This comes as prices hit Point 26. Traders should wait for a small bounce in this area and trades should be executed at Point 27, with stop losses placed above Point 25. This is visible in the chart below, with the short trade entry seen at the thin red line, and the stop loss placed at the thicker red line. Now that our short trade is established, we will need to start focusing on potential price targets. The projected gain is essentially the distance between the blue lines, which is roughly the distance from Point 27 to Point 28, which we would want to place safely above the projection area at Point 10. This can be seen in the chart below: Conclusion: The 3-Peaks and Domed House Pattern Creates Opportunities For Contrarian Traders In the final chart, we can see that the initial structure (reaching the high at Point 23) was validated in a number of different ways. Not only did the chart elements meet the criteria for the 3-Peaks and Domed House but we have added factors as well. If we view these structures differently (as in the final chart), we can see that there are also instances important support levels start to break and a long-term uptrend channel becomes invalidated. All of these events point toward sell positions, and if we were to add an indicator reading (which might suggest that price conditions have become overbought), we would essentially have a perfect storm for new sell positions. Overall, this two-part price pattern is complex in nature, but when all of these elements are identified there can be excellent trading opportunities for those looking to establish contrarian positions near long-term highs.
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