Monday, September 06, 2010

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Trading Strategies

Fibonacci Trading

The Fibonacci indicator is one of the most useful and most widely used tools in the Forex traders arsenal. This indicator is one of many tools that traders have invented but there is no real scientific backing for why it works. This indicator works because everybody believes it will work and everybody uses it therefore it becomes a self-fulfilling indicator. That is why it is important to know how to use it. I could explain about the Golden ratio and all the science behind the Fibonacci formula but that's all really just fluff. What you do need to know is that you draw Fibonacci retracement line from the lowest point in a trend to the highest point of a trend on your chart. You charting software will take care of the rest. The important levels to know the 38.2%, 50% and 61.8% lines these are the most common price levels currency will retrace to after a strong trend. Many traders will pay attention to these levels and will buy or sell accordingly.

Here is an example of the fibonacci retracement levels in action on a 30 minute chart. We have a sharp rally, so we start the fibonacci point at the lowest point of the rally, and place the final point at the top of the rally. Notice how the price trends down and just barely touches the fibonacci 38.2% line before bouncing off. It then ranges between the 23.6% and 38.2% levels until making it's way lower to the 50.0% level. But notice how clean these lines act as support and resistance. There are several trades on this graph, depending on when you noticed the price reversal. If you noticed it early enough you could sell the currency with a profit point of about 10% above the 38.2% level.

If you noticed it after it had already hit the 38.2% level, you could trade the bounce from 38.2% to the 23.6% level. Using the 10% rule above and below the fibonacci lines to set your entry, stoploss, and profit points.

th_fibonacci retracement 38.2


Here is another example of the fibonacci levels at work on a longer term chart. The beauty of the foreign exchange is that all of these technical indicators work on all the different time frames. In this graph we have a strong rally over a period of days with a range from 1.3805 to 1.4138, about 330 pips. Notice how the fibonnacci levels work here, there is a strong retrace all the way to the 61.8% level, followed by a rally to the 28.6% level. Then a quick break down below the 50.0% level before rallying back up to the 0.00% level (the top of the first rally). Remember this is a 4 hour chart, so there are numerous entry and exit points for these trades. As you can see Fibonacci levels are very powerful, and useful, however, knowing what levels will be hit and how to trade them takes experience.

fibonnaci retracement

 

Homework Trade:

Find a strong trend that has just reversed. This can be on any chart, but is most useful on the longer charts. Then draw a Fibonacci retracement from the bottom to the top of that trend. The first thing to notice is the 38.2% level, carefully watch the price of the currency pair. You are waiting for the price to test that level and then to bounce off. If it doesn't bounce off, we watch the 50.0% and then the 61.8% levels. Once again, the trade you will place depends the difference in pips between a maximum height of the trend and the Fibonacci retracement level. You're waiting for the price to bounce off of these key levels by 10% of the total trading range. Place your stoploss 10% below the Fibonacci retracement line and when you've gained pips equal to your risk raise your stoploss to break even. Your first profit point should be double your risk (difference between entry price and stoploss) to start and then you can take more profit as you rise. When taking profit make sure to note the 23.6% level since many traders will take profit here, and you'll see it act as resistance.

 


 

Multiple Timeframe

So now we're going to put a few concepts together and make a trade. The triple timeframe technique is one of the most widely used in popular trading techniques as it has proved successful time after time. It is a trend trading technique which involves finding the macro trend on a longer chart and then using shorter charts to find an entry point for your trade. The key to this trade is ALWAYS going with the trend. You may counter trade the trend but there is a lot more risk for not a lot of reward.

Chart choice

As a general rule, your long-term chart should be 4 to 6 times longer than your intermediate chart, and your short chart should be 4 to 6 times shorter than your intermediate chart.

For a day trader and the 1-minute, 5-minute and 30-minute charts are good choices for this technique

For the swing trader the 1-hour, 4-hour, and daily charts are excellent choices for this technique

To set this technique up use trend following indicators, such as Bollinger bands or moving averages on your longer-term chart to find the trend. Then use oscillators such as stochastics or RSI on your intermediate chart to identify a likely pull back and finally on your shortest term chart look for support and resistance breakout in the direction of the long- term trend.

Homework Trade:

First we look at the longer term chart for this trade.  This is the 1 day chart for the Euro/USD.  You haven't learned about this yet, but the pattern is a classic 5/3 Elliot Wave Pattern.  From this pattern I can determine that the currency pair has pulled back, before making another leg down.  This means that I can find an excellent entry point to short this currency.  You will learn more about Elliot Waves in the additional strategies section, but for now just understand that this trade will be on a downtrend.

elliot wave


Next we take a look at the 4 hour chart.  Notice where the candle crosses the upper Bollinger Band, at around 04:00 that is our entry point. We watch to make sure that the price bounce off of this upper Band and check our 1 hour chart.

th_multiple time frames2

On our 1 hour chart we have stochastics which are showing that the currency pair is well overbought at the same time that the currency is touching the upper Bollinger Band.  We also see resistance at the 1.3980 level. This is an excellent entry point to enter the trade.  Going back to our daily chart we saw that the last support level was at around 1.3760 3 sessions ago, that's a 220 pip difference.  So we wait for the price to bounce off of the 1.3980 resistance level by 10% or about 20 pips.  We enter this trade at 1.3960 with our stop loss at 10% above resistance or 1.4000.  Our first profit target is again double our risk of 40 pips, so we'll take profit at 1.3880 and when you have gained the amount of pips equal to your risk, in this case 80 pips (difference between entry point stoploss) raise your stoploss to break even. You just eliminated all risk in this trade, and the worst you can possibly do now is gain those 80 pips. You'll find while you trade that reducing or eliminating risk is one of the best strategies that you can follow.

th_multiple time frames

   

Trend Following

In trend trading, the goal is to jump on a trend when the direction is clearly indicated by technical tools and then to ride the trend as long as it continues. For this technique you'll have to know trendlines, trend channels and moving averages.

Trends and Trend Channels

Trendlines and trend channels are the most commonly used technical indicator in the Forex market. They are usually employed to find breakouts entries, pullbacks, prudent stop losses and optimal profit targets. They have withstood the test of time as one of the most profitable trading strategies. Drawing trendlines is simple, just connect the dots. Draw lines connecting the lowest points that the price reached on the current chart, as well as connecting the highest points of the price reached on the current chart. This will form a channel that the price moved in. The channel is slanting upwards then you're in an uptrend if it is slanting downward you are in a downtrend, and finally if it is relatively flat you are trading in a range. Simple enough right?

Trends tend to continue for a long period of time in the forex market.  So it is very useful to be able to spot them quickly and take advantage of them. The uptrend below lasts for a month and if you had caught the wave you could have netted well over 1000 pips.  At 10 dollars a pip on the Euro/USD that's a nice 10,000 dollar trade for a single 100,000 currency lot.

Uptrend on a daily chart:

uptrend

Downtrend

downtrend


Moving averages

Moving averages are basically averages of the price over time. To get a 20 day moving average, you add up the price the last 20 days and divide by 20, this is called a simple moving average. These moving averages are lagging indicators, however, so you can not use them to anticipate a trend, only to recognize one. Moving averages do an excellent job of describing a current trend but they lack the ability to signal a change in trends. When you're watching moving averages is important to look for crossovers. For example if the shorter moving average crosses above a longer moving average that can be considered a buy signal. For this technique, you only need to know how to read a simple moving average. To signify a proper uptrend or downtrend the 10 day, 20 day, and 50 day moving averages should be lined up and not crossing. You'll notice on the chart below, the point where the SMA2 line crosses the SMA3 line on May 20th would have made an excellent entry point for this uptrend.

th_sma

Is important to note that the simple moving averages will often act as support and resistance for a currency. Take a look at the daily graph below where you'll notice  that the price will recede to the moving average for 5 straight sessions but then will faces support, until we have a breakout to the downside.

th_sma acting as support


Homework Trade:

Try to identify trends in the currency that you are currently following. How long has it been trending for, is it in an uptrend or a downtrend or a range? If you find a strong trend, wait for the price to cross the 10 day moving average and then rise off of it then buy one lot. Set your stoploss at 20 pips below the moving average. What you will do is follow the price up. As it rises, raise your stoploss.



   

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