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forex traders could benefit from this knowledge. Most retail forex traders are not finance geek and
have limited knowledge about market dynamics and how forex market operates.
Early Trading Years
I entered the world of forex trading about four years ago and I came from a Management
background. When I started trading, I did not have any clue whatsoever about forex market. I used
to visit different trading forums and financial news websites in search of a profitable system, where
I saw different explanation of price movements. Some financial news website would say that the
reason S !ollar fell against "uro because it reached a #$% fibonacci retracement, whereas another
forum would state that the price fell because it hit &$$ day moving average, other financial experts
would argue that prices fell cause it touched a descending trend line and a bunch of experts would
say that price fell cause it reached a resistance level.
's a novice trader, I used to scratch my head because all these different explanations were too much
for me to grasp and it was hard to keep up with it. 's a result, I used to fill my charts with tons of
indicators, where it was sometimes hard to even see price candles. I knew that there has to be some
logical explanation for all these price movements. So I decided to dig deep and do some research
and find the one idea that above all is what drives the market and is displayed on our charts. It did
not took me long to reali(e that all these price movements, I see on currency charts are result of
supply and demand imbalance. If price is moving up it means there are more willing buyers for that
currency at that point in time and if it is moving down it means there are more willing sellers for
that particular currency. )rice is simply moving from one (one to another (one to fill these orders.
The information I am presenting in this article about Supply & Demand is learned and attained from
numerous sources and I will try my level best to explain it in the simplest of form. Some folks
might disagree with my point of view, but I always believe that two people might see similar thing
and have completely different point of view. So let*s get started+
Definition
,. What is the definition of Supply -
'. Supply is the .uantity of an item available for buyers at a certain price.
,. What is the definition of demand -
'. !emand is the .uantity of an item which is wanted by buyers at a certain price.
,. What is imbalance of Supply / !emand-
'. 0I1 If the available Supply of an item exceeds the demand for it then prices tend to fall.
0II1 If demand for a certain item exceeds the available supply then prices tend to rise.
,. What is )rice e.uilibrium -
'. The market price at which the supply of an item e.uals the .uantity demanded.
2rom above definitions, we now understand what is supply, demand, imbalance of supply &
demand and price equilibrium. 3ow let*s go into further details with some examples.
2rom above definitions, we now understand what
is supply, demand, imbalance of supply &
demand and price equilibrium. 3ow let*s
go into further details with some examples.
Example - Supply Exceeds Demand
2rom the above explanation, we now know that
supply and demand are fundamental driver of
price. 3ow lets look it into simple context to
better understand how supply exceeds demand. 4et*s assume its winter season
and a customer goes to an electronics retail store to buy something. 's he enters a
store he sees a sign board offering #$% discount on air conditioners, but he hardly see anybody
interested in buying it, despite the low price. What could be the reason for it. The simple and logical
reason is since its winter, and the weather is cold, this item is not wanted by buyers cause it*s of no
use to them right now, however since the store is aware that there is lack of demand for this item,
they are offering discounted price to entice buyers. This is classic example of supply exceeding
demand vi(. there is less demand for air conditioner in winter season, but more supply available, as
such item was offered at a discounted price.
Example - Demand Exceeds Supply
3ow lets look at similar scenario to understand how demand exceeds supply. It*s winter season and
a customer goes to an electronic retail store to buy a 5eater, but it was out of stock, so he goes to
another store hoping he would get it there, but unfortunately they are also out of stock. Thereafter,
he goes to third store and finally he sees heaters available, at that store, but the problem is there are
lot of customers already standing in line to buy it. Moreover, there is no discount offered on heater,
in fact the price is much higher than normal, but lot of customers are still buying it. This is classic
example of demand exceeding supply vi(. there is more demand for heater being a winter season,
but available supply is limited. Since many stores are out of stock, this particular store which have
heaters raised the price due to excessive demand.
Example - Price Equilibrium
3ow here is another scenario to understand )rice e.uilibrium. It*s winter season and a customer
went to an electronic retail store to buy a 5eater, there he sees enough heaters available at the store
and some people are buying it. The store is not offering any discount nor the price is higher than
normal. Since there was enough .uantity available for this item and limited number of customers
are buying it, the customer decides to check another store to see, if he can get a better price. 5e
knows that this item will not be out of stock for the time being, so he visits another store and notice
the same scenario as store one. This is classic example of price e.uilibrium vi(. a supply of heater
by retail store / demand by customers are e.ual, as such price is not at discount nor it is higher
than normal.
How to identify Supply & Demand e!els on "orex #$art
3ow that we have better understanding of price e.uilibrium and imbalance of Supply / !emand.
We will go a step further and see how we can benefit from this knowledge in forex market.
's in any market the purpose of trader 6 speculator 6 investor is to buy an item or instrument at
discount 0wholesale price1 and sell at retail price, the forex market is no different. We as retail
traders are unable to see actual buy6sell orders in forex market, but we can apply our knowledge of
supply / demand to identify our next level of interest, where we believe smart money 0large
players 6 institutional traders, real market movers1 are most likely to place their orders. 7ur main
area of interest would be, where price made a substantial move from a particular (one and where
actual imbalance of supply and demand between buyers and sellers occurred. It could be a series of
candles or one candle, but it should clearly show a decision point where either buyers or sellers took
charge. 7nce a (one is identified, our 8ob is to wait until price approaches that (one again. We could
either place a limit order or watch price action to enter trade at that (one.
's with any system or strategy we cannot be &$$% sure that price will again respect that (one, but
there is a higher probability than not that price would react at that (one, considering the way price
left that level the first time, suggest that buyers6sellers consider it as an important (one. 4et*s look at
attached chart example, which is self explanatory+
Price Structure
There are four common structures that are used to identify supply / demand levels on forex charts+
&1 !rop9 :ase9 ;ally
<1 ;ally9:ase9!rop
=1 ;ally9:ase9;ally
>1 !rop9:ase9!rop
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I firmly believe that once a trader understands supply / demand dynamics and trade with patience,
discipline and proper risk management, he6she could achieve success in trading.
Here are some of my fa!orite %uotes from successful traders&
!on*t think about what the market*s going to do, you have absolutely no control over that.
Think about what you*re going to do if it gets there.
'll we can do at best is look for historical reasons and apply this to a level or price area for
possible future moves. Trading is neither science or art, it is a reflection of what value
humans place on a particular financial instrument at a given point in time.
If you must play, decide upon three things at the start+ the rules of the game, the stakes, and
.uitting time
T$e Holy 'rail of Trading ()*)+
Risk Management / Part 2 - by Ken
)art & of this article can be found here 9 @
In the following practical demonstration of ;isk Management, I have scrolled ";6S! chart back
to 7ct <$&$ as the starting point of this exercise. Ahart contains only Ahaos Semafor indicator for
showing = levels highs and lows. )urely for information not for our entry and exit decisions.
Time to get on with our &$ exercise trades.
Trade ,&
We have one fresh supply (one and one demand (one. The fresh word here refers to (ones are not
been visited by price yet. Then we have some mid supply (ones which we will ignore unless we see
some decent opportunity. 3ow we wait and see what price does.
3:. I use an alert indicator which plays a sound when price is approaching wherever I place the
alerter's horizontal line. I don't have to sit and watch the price on any particular chart. lease see
end of this article for the indicators mentioned!used in this e"ercise.
See how price sliced through the first mid9weak (one. We cannot see any decent )' here to prompt
us to sell, especially considering demand at bottom was established with an engulfing candle. So we
ignore it. If upper supply works and price turns down towards demand then so be it. We*ll wait for
the next opportunity. !o not worry about missed opportunities. Markets present no ends of entry
opportunities on a daily basis.
's expected all weak (ones are taken out. 'fter price touched the main supply (one we have been
watching, it produced a 8uicy bear engulfing candle. 3ow we are looking for an entry opportunity
that fits in with our ;isk )rofile. It comes first and second candle after the engulfing one. Since we
are all excited and cannot wait we enter as soon as price hits our stop range. 3ow we have to wait
and see without doing anything stupid in the meantime.
)lease note that this entry doesn*t fit conventional supply and demand trading. Textbook entry
would have been when price traveled further up within supply (one so that we can have our >$ pips
stop 8ust outside Babove the upper borderC the supply (one. 5owever, after price hitting supply (one
then seeing such a nice engulfing bear bar we decided it*s worth taking the risk and entered at first
possible opportunity.
The price hit our first target. !ecision time. !o we close or let it run- 7bviously, we don*t take a
long time here to think about closing or not. We should already have a pretty good idea by now
what we*d be doing when price hit the TD&.
We already know that best possible signal we hope to see on charts is a nice engulfing candle on
right place. Meaning in and around strong (ones. We have a nice engulfing and a decent )'. In this
occasion we decide to move our stop break9even E, define TD< and let it run.
Since price sliced through our TD<, we decide to move our stop to TD< and let it run. 4ooking for
the price to hit the bottom demand or at least come bit more close to it.
We were proven to be right on this occasion. With patience and without unreasonable fear we have
managed to maximi(e our gain by sensible trailing. We put our third and final target 8ust off the
demand (one to ensure .uick exit. 7ften price can mess around before hitting the actual (one.
Some may ask why that bull engulfing candle pattern on the way down didn*t work. 4ook at where
it formed- !o you see any decent (one around there- :esides, we put off from our entry radar
levels between the supply and demand (ones we decided to trade.
)lease note that not all price movement as straightforward as the above one. That*s why it*s very
important that when we catch a nice opportunity we don*t waste it with premature exits.
Trade , is closed wit$ )-. pips gain/
Trade )&
In accordance to our ;isk )rofile and dirt simple trading plan we take the buy in the demand (one.
7ur stop works out to be 8ust outside of the demand (one which is ideal.
3ow, there are various approaches on entries in and around supply and demand (ones. Some enter
when price hits the (one, some wait and see if the the candle makes it into (one, closes inside the
(one, or goes through therefore invalidate the (one. There are others who wait to see if price is
going to be contained in the (one by watching )' to give them some clues.
"ach approach has it*s own advantages and disadvantages. Waiting for )' confirmation may take
some time and it*ll most likely will happen outside the (one thus increasing stop pips count. 7f
course it*s still not guaranteed it*ll work. 7n the other hand taking the trade when price hits the (one
will reduce our stop pips count but we do not have any indication or clue if it*ll be contained within
the (one or not.
In my case I do not subscribe to any particular one. I use all of them depending on the (one and how
price travels, the speed price hits the (one. The above is a good example of for the first approach.
We have a fresh fairly strong looking (one which is established with an engulfing bull candle and
hitting the (one with fairly big 5& candle.
's you can see price hit our TD& nicely. Instead of closing we expanded our TD to about from F$
pips to &<$ pips and moved our stop to break9even E &G pips. 7ur TD< is almost hit but not .uite.
Since we moved :" to plus &G pips we can afford to wait and see.
'll looking good so far. We locked our trade. We are fairly safe. We won*t be taking any loss on
this trade unless something unexpected happens or we leave this trade like this over the weekend
and market gaps down to well below our entry price.
TD< also hit with a nice big bull candle. Instead of closing we decided to trail. Moved TD further
up and moved our stop to break9even E &<< pips.
We could have moved our TD further up but notice the left boxed dirty price action (one. We don*t
want to get involved in any dirty price action. It*s best to take what we have Bonce hit the dirty (oneC
and run. If TD= hit we*d be achieving over >+& reward ratio. 3o point getting greedy. If it slices
through the dirty (one so be it. We*ll wait for the next opportunity.
's this trade is fairly secured, we may go ahead and look for another trading opportunity on another
instrument.
TD= is hit comfortably and Trade ) closed wit$ ,0. pips gain/
There is a nice bear engulfing candle in dirty (one which established a new supply (one. Why didn*t
we take a sell order around there. Well we already decided we*ll only trade clean and strong (ones.
What about that current bull engulfing candle then. 're we not going to trade it- Hes we would
consider this buy after a good engulfing bull bar around previous spike. 'dditionally, price has been
bounced from fresh demand and not reached any serious supply yet. 5owever, we cannot take this
buy trade as stop would be bigger than our ;isk )rofile allows us. We need to wait for the next
candle and see if it*s going to come to within our >$ pips range.
Trade 1&
nfortunately, price didn*t come down enough to allow us enter with a maximum >$ pips stop as
defined in our ;isk profile in fresh demand (one. 5owever, we took a sell order in fresh supply
(one without waiting candle finish or )' config. 'll was good other than amount of time price took
to reach supply (one.
's you can see it hit our stop and this Trade 1 closed wit$ 2. pips loss/
Trade 2&
' new (one established at new high with an bear engulfing candle. If the risk is small, newly
established (one looks attractive, looks a worth try. We will have to wait and see what kind of risk
level it*ll offer on the next candle.
We have our entry with bit lower than our maximum stop of >$ pips
Instead of closing we decided to trail as the candle following the one hit the target worked out
nicely. So, we moved the stop to TD&. 4ocked our F$ pips gain and moved the TD further down.
'gain instead of closing we decided to trail. Selling pressure looks .uite promising. 'lready sliced
through a minor ranging (one and gunned into bigger one. !ecided to go for the full monty by
moving target all the way down. 5owever, this doesn*t mean we will not keep trailing at reasonable
distance.
Target hit on weaker demand (one. Trade 2 closed wit$ 2.3 pips gain/
're we going to buy here- 3ot as yet. It*s a weak demand (one and we don*t see any convincing )'
as yet. So, we wait and see.
3ow we have our bull engulfing candle. 7nly downside is it*s on a weak (one. We can not take the
entry as yet. )rice is well out of our stop range.
Trade 3&
"ven though )' and levels have some warning signs for buyers we went ahead and bought it.
Managed to reduce stop si(e to <I pips.
Stop is hit. Trade 3 is closed wit$ )0 pips loss/
4ower main (one hit. We have to remember it*s no longer fresh (one. This is the second visit. We
cannot enter a buy. It*s outside of or stop range.
Since the lower demand was not fresh we decided to wait and see the finish of the big bear candle.
"ventually, it took out lower demand. "stablished new supply (one and selling pressure is still on.
Trade 4&
"ven though it*s a minor supply we take the sell trade almost within the (one. We could have sold
bit higher and therefore reduce our stop amount but we wanted a bit of )' confirmation. ' weak
but some indication that sell is still on. We had better indication as to where price may be heading
on the near left. 3ote those big engulfing bear candles within6around the supply (one.
Some call it previous demand (one turned into supply (one. That*s a bit too techie for me. The fact
is that sellers are in charge as we can see on the chart. 'll the remaining buyers from the origin of
the demand (one already used their buying power and remaining ones are wasted at subse.uent
visit.
'dditionally worth noting that we see on the charts new lower highs and two demand (ones are
taken out without much difficulty. "specially the lower main one taken out with such a (eal that we
need to take notice of heavy selling pressure. What this means is that selling the peaks may be
better option than buying in minor demand (ones.
When TD& is hit, we moved our stop :"EG and TD< to &&F pips. We let it runJ trusting our analysis
about heavy selling. We could have taken well over &<$ pips with further trailing but let it run and
it*s almost hitting our stop.
7n this occasion we got back previous low, but sometimes price takes the stop by a couple of pips
or so. 2or those who cannot handle frustration when such thing happens best to trail more closely or
close the position when TD& is reached.
Trade 4 closed wit$ ).- pips gain
Trade 0&
Why we took this long entry when we were convinced there are heavy sellers and were saying best
to sell peaks. )rice created a form of gap and hit the re8ection point. This knowledge may be out of
the beginner*s domain. So, lets 8ust say we see heavy selling up to a certain point then re8ection.
Since it fits to our stop range we want to try this newly established (one.
Kust short of our TD&. It looks turning against us. We don*t want the winning trade to turn into a
looser so we moved stop to :"E&$
Since we have a nice bull candle it would be shame to close here rather than trailing. So we move
the stop to TD& and TD expanded to TD< for &L$ pips.
TD< is hit and decided to close due to price structure on the left. Trade 0 closed wit$ ,4. pips
gain/
Trade 5&
Since we already have a supply (one 8ust above, we have decided to go with the newly established
supply (one 8ust below the existing one.
Note: #onventional supply and demand trading method advises us to wait for the price to visit the
established zone before entering the trade. $he reason for this is that establishing zone usually
ta%es more than a couple of candle. &owever, in this e"ercise we have been ta%ing trades 'ust after
a zone created. (e go in early if we see attractive ) when establishing a zone. )nd of course we
always %eep left of the chart under constant observation. (e loo% at left and trade the right.
Trade is developing nicely. TD& is hit. Instead of close we have moved stop to :"E<G pips and
expanded the target all the way down to near demand. 3ow we are targeting 8ust over <#$ pips. It
would be real nice if we get it. That would be over &+L reward ratio.
What the heck.. Since price moving nicely in our direction we have the opportunity to move stop to
our TD< and let it run. 5eavy selling pressure. We know overall market direction is south BdownC.
The downside is if it turns from here we*d be loosing a buy entry in demand (one.
!emand is taken out with ease. We have locked &+I reward ratio by moving our stop bit further
down. 3ow we can sit and relax. 4et the price do it*s thing. See what else it may offer. 't this point
it doesn*t matter a bit if it turns and hit our stop. If it doesn*t then we may be onto something bigger
here. 5owever, we will still trail it at a reasonable distance.
;un is still on. We have no rush to exit. We 8ust have to keep our greed in check here and let the
price do it*s thing. 'fter all we don*t catch such moves every day.
Traders with enough screen time will know that once price hits an important psychological level it*s
bound to react. We are trading ";6S! and it hit sub &.=$. 4ets assume we are new and not
familiar with such stuff. So we leave our trailing as it*s at L#< pips.
's expected bounced from new territories of &.<G. 7ur stop is hit. Trade 5 is closed wit$ 43) pips
gain/
Trade -&
We have missed the lower demand while waiting for our previous trade. !ecided to enter a long on
upper demand. Aouldn*t take previous hits as it was not in range of our stop. 's you can see our
initial TD is already hit. 3ot closing it. Moving stop to :"E and expanding the TD.
We will start trailing here as we don*t want to give back most of our gains.
Since it took out previous highs we keep trailing it. 'lready secured about <F< pips. 4et see if
market is willing to give us more.
Alosed here manually after seeing re8ection and especially engulfing bear candle. Trade - closed
wit$ 1.0 pips gain/
Trade &$+
We couldn*t take the sell order as it was 8ust outside our stop range by & or < pips. We 8ust cannot
say what*s & or < pips. We could take that sell. 4ook how it worked fine. Hes, but we cannot
compromise on our ;isk profile. 7nce it*s defined we must keep it*s rules to the pips, until we
decide to work out a new one. We 8ust cannot work out a new ;isk )rofile to fit in our current trade.
So best is too keep it if it*s working until it doesn*t over a period of time. !iscipline must be there at
all times.
We enter a buy order in newly established demand (one with smaller stop than our maximum.
Initial TD is hit. 'gain instead of close we started to trail by moving stop :"E=# and expanding the
TD.
nfortunately, on this occasion price didn*t go in our direction. It hit our stop. Trade ,. is closed
wit$ 13 pips gain/
M'A!
6ntroduction
So, we*ve looked at what the M'A! is, where all it*s components are derived from and what trading
signals it produces. 3ow we*re looking at how to trade with the M'A!. Traders use the M'A!
indicator in a number of ways to realise a trading opening.
The M'A! !ivergence
The M'A! 5istogram Arossover and !ivergence
The Signal6Trigger 4ine Arossover
The M'A! (ero line crossover
In our last section on The M'A!, the indicator is best used in trending mar7ets and s$ouldn8t
really be used in range bound mar7ets 9 not e!en to predict a new trend/ T$e :;#D
indicator allows us to determine $ow strong a trend really is 0or if weMre in a range1. If the
:;#D is $o!ering and flat around t$e <ero line t$en t$is identifies a range bound mar7et
and if t$e :;#D is trending strongly t$roug$ or from <ero =up or down> t$en t$ere will be a
strong trend trend. We can see this in the below Mc!onalds Ahart.
sing M'A! to Identify Trends
So the M'A! and it*s histogram should be used for trading in trending markets. 7nce we have
established a primary trend 0!ow Theory Tenet &1 there are a number of ways we can trade wit$
t$e :;#D on t$e continuation or t$is trend from it?s retracement 0Secondary Trend1.
Trading t$e :;#D Di!ergence
The M'A! !ivergence is either loved or hated by traders and often gives us false signals. The
!ivergence between the market price and the M'A! is signalling weakness in trend. When the
M'A! is moving in the opposite direction to the market price this is a signal that the markets
momentum M'H reverse at some point. :e aware though, that there are plenty of situations where
trend hasn*t reversed on M'A! divergences.
In the below chart we have examples of positive and negative divergence. )ositive divergence is
seen when the M'A! is increasing 0making higher peaks and higher troughs1, while less than (ero,
against a downtrend in price 0lower peaks and lower troughs1 N This is a :ullish !ivergence
0although the market is still in a bearish primary trend, we anticipate a bullish retracement or
reversal1. ' negative divergence occurs when The M'A! trends down, while above (ero, against
an up trend in price N ' :earish !ivergence.
These !ivergences occurs because the current price momentum still outpace itMs, growing opposite
momentum. This opposite momentum may take some time to be strong enough to win the day. Hou
can see in this case the Momentum did change while the M'A! was in positive and negative
divergence, indicated by the yellow line.
M'A! !ivergence
The M'A! divergence is an indicator which really needs to be used in con8unction with other
indicators. The M'A! divergence tells us trend may reverse at some point due to a shift in
momentum. 7ther indicators needed will include volume. Oolume is important here because as
momentum wanes volume should decrease, indicating a lack of conviction in the current trend.
T$is di!ergence =along wit$ $istogram resistance> is particularly useful if t$e di!ergence
s$ows a secondary trend =retracement> possible re!ersal/ This may indicate the primary trend is
about to begin again, which is a signal for trend traders to enter the market.
6nstead of an indicator t$at is going to trigger trading signals@ :;#D Di!ergence is really an
early warning system/ Many traders will wait for the trend to confirm its reversal before entering
the market 9 using t$e :;#D di!ergence as a filter@ only entering :;#D*signal line crosso!er
signals after a di!ergence. 's we can see in the above chart the green circles represent possible
entry points where the M'A! crosses the signal line. Trend traders may give the &st circled entry
point a miss, as it*s against the primary trend and hopefully 8ust a retracement to the downward
trend resistance line. The <nd entry point would interest a trend trader though, as it*s signalling a
trend and momentum continuation. Many divergences will last for a long time, so patience is
needed.
Trading t$e :;#D Histogram
's well as setting up trading strategies around the M'A! divergence and its signal, traders may
also set up trading strategies around the M'A! 5istogram. ;emember, the M'A! histogram is
a derivative of the M'A! and it*s G day M' signal 9 measuring the distance between the two,
therefore changes in momentum. There are two ways of using M'A! histogram to trade 9 The (ero
crossover and the divergence. The crossover will produce actual trading signals, where momentum
and trend has changed, while the divergence is more subtle. The histogram divergence is almost a
filter, or early warning system. It allows traders to see slight changes in momentum 0even though
price trend looks the same to the naked eye1, which may lead to a full blown trend reversal in the
future. Traders may filter out all M'A!6signal line triggers that aren*t associated with a
divergence.
Trading t$e :;#D Histogram Aero #rosso!er
The 5istogram (ero line crossover occurs when the M'A! e.uals the M'A! G9day moving
average 0it*s signal1. It*s exactly the same as trading the M'A!6signal line crossover as discussed
later in this section, 8ust graphically different. So, we won*t spend much time on it here.
Trading signals are triggered when the the histogram crosses it*s (ero line. When the histogram
crosses above the (ero line buy signals are triggered and when the histogram crosses below the (ero
line, sells signals are generated. I*ve shown this in the chart below. 's shown these signals occur
when the M'A! and it*s signal cross. 7nce again, the :;#D $istogram s$ould only be used in a
trend following strategy/
Trading The M'A! 5istogram Arossover
Trading T$e Histogram Di!ergence
The histogram divergence is used to anticipate a M'A!9Signal crossover 9 an early warning system
if you like, when trading with the trend. It can be used effectively as a filter to all those
M'A!6signal line crossovers, filtering out crossovers that donMt have a divergence associated with
it. There are < types of histogram divergence 9 The )eak9Trough and Slant divergences. In both
cases a full9bodied di!ergence generating o!er a few wee7s is a better indicator than a shallow
divergence developing over a few days N so go long and large, not short and shallow.
We have two examples of the Pea7-Troug$ Histogram Di!ergence N one )ositive and one
negative. ' negative 0or bearish1 divergence forms when the histogram makes consecutive lower
peaks and the M'A! and price form consecutive higher peaks N price momentum is weakening in a
similar way to the M'A! divergence above. This can be seen in PThe M'A! 5istogram )eak9
Trough 3egative !ivergenceP Ahart .
We have a histogram negative divergence indicating a possible price reversal to the bearish side.
This price reversal is confirmed when the M'A! crosses below the signal, which could be a trade
entry point to short the S! against Kapanese Hen 0green circle1. 's with the M'A! divergence
the 5istogram divergence indicates many false trade signalsJ so itMs used as part of an overall
trading strategy where other trading tools are also utilised.
The M'A! 5istogram )eak9Trough 3egative !ivergence
' )ositive histogram !ivergence forms when the M'A! and price form lower troughs and the
histogram forms higher troughs N price momentum is turning away from the downside, to a bullish
trend. This can be seen on the above chart QM'A! 5istogram )ositive !ivergenceR where the
lower well9defined troughs on the M'A! are highlighted in ;ed and the 5igher well9defined
troughs in the histogram are highlighted in green. 3otice M'A! moved to a lower low in late May,
but the histogram formed a higher low. It follows, if traders are using this divergence as an early
warning signal before committing, a good entry level maybe Kun Lth or Kun &=th when the M'A!
crosses above the signal6trigger. ;emember, this is a trend following indicator.
The M'A! )eak9Trough )ositive !ivergence
T$e Slant di!ergence acts the same way as the peak9trough histogram divergence, but is minus the
peaks and troughs. The 5istogram in both the positive 0bullish1 and negative 0bearish1 divergences
will slope towards the (ero line indicating that price momentum is wea7ening and the price of the
security is maybe about to turn. 0;emember the histogram measures the distance between M'A!
and itMs G9day moving average signal line. Momentum weakens as these lines converge1.
In the below chart we*ve (oomed into a section of an I:M weekly chart following a primary up
trend. Within this primary up trend we can see two retracements. Two positive histogram slant
divergences have been highlighted, where the histogram diverges with the price and the M'A!
itself, indicating a momentum change. If traders are using the histogram divergence as an early
warning to possible momentum change then they will act on the buy signals where the M'A!
crosses the signal line 0or where the histogram crosses (ero1. These buy triggers are highlighted
with green circles. These two bullish divergences bring I:M out of retracement back on to the
primary trend.
Hou can also see two negative divergences, one a peak9trough divergence 0May9Kul GG1 and one a
possible slant divergence 0!ec GF1. Trend traders will use these negative divergences to highlight
where the primary trend maybe about to retrace and sell on the M'A!9signal crossover.
;emember, other indicators should be used as part of your trading strategy.
T$e :;#D Signal*Trigger #rosso!er
We touched upon the trading possibilities of the M'A! price crossover in the section N QThe
Moving 'verage Aonvergence !ivergence N M'A!R. The signal crossover is the most common
M'A! signal 9 when the M'A! crosses above the G9day "M' 0"xponential Moving 'verage1
trigger line a buy 0or exit the short1 signal is created and when the M'A! crosses below the signal
line a sell6short signal is created. T$is is a great signal confirmation in itself@ or Bust after a
di!ergence and is generally traded with other indicators to get a clearer picture of where
momentum is going. 'gain, this is better used in trending markets.
:elow, we have an S/) #$$ hourly chart in a primary up trend. We can see how traders utilise this
indicator in a trading environment. 7n the <<nd the M'A! 0:lue line1 crosses below the G9day
"M' trigger line. This indicates that traders should sell a long position. Indeed, momentum shifted
to the downside until the M'A! crossed above our trigger 0white line1 on the <Ith. This crossover
on the <Ith is a buy signal where momentum reversed again to continue the primary trend. In effect
the area between this sell signal and buy signal is a primary trend retracement.
The signal to exit this long position comes on the #th when the blue M'A! crosses under the white
signal. Trend traders may sell here and await the retracement to follow it*s course. 7n the Ith we
can see a criss9cross buy6sell signal. 'nyone entering a buy here would have been burned, as price
continued to fall and a .uick strong sell signal developed. In fact we can see a negative divergence
here, indicating a turn in momentum to the downside. This turn to the down side may have been a
retracement or full blown trend reversal. 7ther indicators need to be utilised to indicate whether the
retracement is to continue,or not... se volume, 2ibonacci retracements and see where support and
resistance are before trading.
M'A! Signal 4ine Arossover
In the above example I*ve indicated that traders will sell on the retracements and buy on the
continuation of the primary trend. This may not be the case for all traders. 's part of a trading
strategy, a long9term trader may be happy to keep his long position going into a retracement.
5e6she may have a long position that only gets sold when long term trend lines are broken, or when
previous support areas are lost. :y the end of this course, hopefully you*ll be aware of many
trading strategies and pick the one best for your needs.
If you find yourself in a situation where you see a buy signal crossover 0M'A! crosses above G9
day signal1 above the (ero line. or a sell signal crossover below the (ero line, this indicates
momentum is continuing and these signals are still valid. Kust be aware of any divergence that you
see, indicating the possible change in momentum in the future.
T$e :;#D Aero ine #rosso!er
's the name suggests the M'A! (ero line crossover highlights buy6short positions that may be
profitable to a trader. C$en t$e :;#D crosses t$e <ero line it indicates t$at momentum $as
already re!ersed. Traders will employ other indicators into their trading strategy to try to
determine whether itMs still a good trade to enter into. To determine a strong trading signal The
M'A! will pass the (ero line in a strong manner at a decent angle. This will also coincide with a
strong histogram indicating good price momentum continuation. If the M'A! crosses (ero flatly or
8ust above the (ero line this indicates a range, which isnMt good to trade with The M'A!.
In the Ahart :elow This strong signal is highlighted on the left where the M'A! is also moving
away from the G9day trigger line. This strong M'A! and rising histogram 0the difference between
M'A! and trigger1 shows good rising price momentum N a good buy signal. In this situation the
trade sell signal occurs when the M'A! crosses under the signal. 's the M'A! heads towards
(ero a QM'A! (ero line crossoverR trade should be anticipated, but only if it crosses in a strong
manner. We can see that when the :;#D crosses bac7 across <ero and t$e $istogram is strong
9 a good s$ort signal. We can exit the trade at the next M'A!6signal crossover.
In the below example out trading profits are indicated by the green and red trend lines. If we had
traded the M'A! signal6trigger crossover our profits would have been greater between the two
trades 0indicated by the grey trend lines1. 5owever, using the M'A! (ero line crossover is an extra
confirmation that momentum has turned and strong, as well as triggering less false signals. In effect
the (ero line crossover is another way of looking at the double moving average crossover, as when
the M'A! crosses (ero, the < moving averages cross each other.
M'A! (ero line crossover
#$anging T$e :;#D Parameters
The standard setting for M'A! is the difference between the &< and <L9period "M's. Ahartists
looking for more sensitivity may try a shorter short9term moving average and a longer long9term
moving average. M'A!0#,=#,#1 is more sensitive than M'A!0&<,<L,G1 and might be better suited
for weekly charts. Ahartists looking for less sensitivity may consider lengthening the moving
averages. ' less sensitive M'A! will still oscillate above6below (ero, but the centerline crossovers
and signal line crossovers will be less fre.uent.
To Sum Dp
The M'A! and M'A! 5istogram are great for spotting trend, identifying changes in trend / price
momentum and establishing trading trigger entry / exit points. Many trend following trading
strategies will have M'A! at their heart. The M'A! can*t tell us if prices are overbought or
oversold though and as the M'A! is a derivative of price it*s difficult to compare Momentum
against different stocks, or against historical prices of the same market. :ut it*s uni.ue in bringing
together trend and momentum. To compare other markets and historical prices we can use the
)ercentage )rice 7scillator 0))71. This is M'A!*s cousin and we*ll talk about this next.
We can set the indicators price action sensitivity. The sensitivity of the indicator to price action
determines how .uickly the trader enters the move and how accurate these trading signals are. If the
indicator is set to low sensitivity then you generate less false signals, but you may see the move too
late, or not see it at all. With high sensitivity you are more likely to catch the move into the trade,
but you may generate false trading signals. 2or instance a swing trader 0trading with a hori(on of >
to # days1 may set the M'A! to =, &$, &L once they*ve drill down to an hourly chart from a daily
chart. ;educing the parameters of the moving averages will increase the sensitivity and highlight
more signals 9 good and bad. Dood charting software will allow the parameters to be changed.
Technical analysis is not an exact science and although these indicators can increase the probability
of making the correct trade, many will go against you and large losses can be incurred. Hour own
trading strategy needs to be formed and hopefully you*ll be on your way to achieving this on
completion of this course.
6ntroduction
2ibonacci 02ull name+ 4eonardo )isano1 was a &=th Aentury Italian mathematician who developed a
se.uence of mathematical numbers, which described how life is bound by the same mathematical
principles. We can use his findings to interpret 0in mathematical and charting terms1 how the
individual ceases to act alone, but acts as a collective, making group decisions. We*ll find out how
2ibonacci*s 0shortened to 2ib*s1 mathematical relationship between his se.uences of numbers and
crowd mentality plays a critically important role in charting, as well as in nature itself. ' more in
depth look at 2ibonacci numbers can be found on Wikipedia etcS but for now, we as traders only
need to know the basics.
2ibonacciMs numbers are+
$, &, &, <, =, #, F, &=, <&, =>, ##, FG, &>>, etc.
"ach number is simply the sum of the < proceeding numbers. ItMs remarkable characteristic is the
ratio between the numbers 9 "ach number is approximately &.L&F times greater than the proceeding
number. This ratio strengthens as we climb higher in numbers. In mathematical learning this is
sometimes called retracement studies.
The key 2ib ratios are+
L&.F% 0the golden ;ule1 9 !ivide & number by itMs following number. I.e. &=6<& T $.L&G
=F.<% 9 divide & number by the number < places up. I.e. ##6&>> T $.=F&G
<=.L% 9 divide & number by the number = places up. I.e. <&6FG T $.<=#GL
The ratio of 4,/5 is 7nown as t$e E'olden FatioG. ItMs found in all walks of life and forms the
building blocks in the laws of nature. The golden ratio can be seen throughout the mathematical
construction of nature N 2rom architecture, sunflowers, snailMs shells / spiral galaxies. 2or example
the ratio of female bees to male bees in a hive is &.L&F and the difference between the distance from
your fingertips to your shoulder and your fingertips to your elbow has the Dolden ;atio. T$is
'olden Fatio is also found in finance.
"ibonacci in Tec$nical ;nalysis
The &st thing to note is, when using PThe 2ibonacci ;etracementP we are working on the basis that
a trend will continue and the reversals are corrective in nature. In other words the retracement*s are
temporary pull9backs and up9turns within a larger trend. The section on Pretracement or reversal N a
checklistP will help to identify whether the trend is correcting or reversing.
Most Aharting Software will have the 2ibonacci Tool that can be utilised by chartists. The 2ib
retracement is created by taking < extreme points 0usually a peak and trough1 on a chart. The
extreme points of the 2ib are divided vertically by 2ibMs ratios N <=.L%, =F.<% and L&.F%. ' #$%
retracement is also added, because it is an important psychological number. This #$% level was
derived from !ow theory and the assertion that a #$% retracement is psychologically on the mind
of the collective. These ratios between peak and trough are then drawn hori(ontally on the chart and
are used as stated in the above paragraph to highlight potential trend retracement support and
resistance areas. These areas are useful for trade entry and exit.
W2M 9 2ibonacci ;etracement
The above Whole 2oods chart shows how 2ib is drawn and used. The 2ib is drawn between the
trough of a trend 0price U=>1 and it*s peak at ULL.#L. The charting software automatically draws on
the ratios at <=.L, =F.<, #$, L&.F and &$$ 0Sometimes a IF.& will also be drawn1. See how, as weMve
circled, these ratios offer reversal, support and resistance opportunities. HouMll see that &$$ on our
2ib scale 0right hand side on the chart1 signals the start of the drawn line, this is because it will take
a &$$% price reversal to get back to this price level of U=>.
"ibonacci ;ssumptions and Fules
These ratios donMt always hold, but do offer good technical indication for the trader especially when
used with other indicators and price action. Since '44 traders are aware of 2ibs and use them
WI!"4H the ratio levels tend to become self9prophesising, especially is you draw the 2ib between
obvious peaks and troughs. 2ib lines can be drawn from candle body to candle body, or from
shadow 0or wick1 highs and shadow lows, but itMs best not to mix bodies and shadows. They can
also be drawn from any peak, trough in any timeframe and be perfectly valid in tech analysis.
5owever, "ibs wor7 better o!er t$e longer term. The shorter the timeframe then the less reliable
the data can be as volatility skews support and resistance levels. ItMs like any survey N the more data
the better the result. 2ibs can be used in any chart time9frame, but 8ust bear in mind that itMs better to
use multi9time frame analysis focusing on a daily chart over a longer period prior to focusing down.
'lways use other tech analysis in con8unction with 2ibs. Aandlesticks, )rice action, volume, chart
patterns / indicators are always worth confirming &st.
Trading "ibonacci - ; eading 6ndicator for Entry
2ibonacci is sometimes thought of as leading indicator particularly if used in a trend. 's we
have discussed price doesnMt always go up in a trend, as a trend has periods of consolidation.
Traders will use 2ibonacci ;etracement to predict the price downturn6up turn in a period of trend
consolidation and then look for entry points if the trend is to continue. T$e "ib le!els of )1/4@ 15/)@
3.@ 4,/5 are ;lert Aones that traders can anticipate trades from N hence a leading indicator. Veep in
mind that these fib levels are not hard reversal, support and resistance levelsJ but are <ones for
potential tec$ analysis.
In our example of ";6S! below in mid 'pril a strong up trend reached a long consolidation
point until late 'ugust where the trend continued with higher lows and higher highs. This
bottoming of the consolidation occurred on the #$% 2ib retracement line where the currency pairing
bottomed a couple of times before taking off. IMve circled the #$% 2ibs that traders Many looking to
enter at. HouMll also see a =F.<% retracement where bull traders entered, but this rally was very
short lived. ;s a leading indicator T$e "ib is allowing traders to forecast w$ere a re!ersal
:;Y ta7e place and M'H indicate trading opportunities when used with price action and
technical analysis. ' trend is deemed stronger if the consolidation hits the =F.<% retracement then
rebounds to continue the trend.
";6S! 9 2ibonacci as a 4eading Indicator
"ibonacci Trading #onfirmation
Aombining 2ib retracement with other tech analysis is a must. In our ";6S! chart above we
have a stochastic oscillator. 3otice how an oversold <$ crossover line, a stochastic 6 # period M'
cross over and #$% retracement align on the <>th6<#th 'ug. ThereMs also a spinning top indicating a
possible reversal 0See )rice action Module #1. :efore trading, traders like to get confirmation.
Aonfirmation in the way of+
' double confirmation of 2ib support levels
Aandlestick patterns 0see price action module #1
Increased volume on trend continuation
Moving averages support / resistance levels met
Trend 4ines Met
)revious ;esistance becomes support and vice9versa 0below chart1
4ooking back at previous support and resistance levels is a good idea to get confirmation that the
2ib retracement is holding. These historical levels can be previous 2ib extension levels, or other
levels set by moving averages, significant round numbers, etc... In the chart below, look how a
previous resistance level now become support and this coincides with a #$% retracement. This
level is highlighted with a blue line. This #$% 2ib ;etrace, is not only support from a previous
resistance level, it also holds = times. This is good trading confirmation.
S!6A52 9 2ibonacci "xtension now becomes Support
Trading "ibonacci - Setting Profit Targets wit$ t$e Extension
2ibonacci can be used to calculate profit9taking levels. WeMll use the same 2ibonacci set9up as
above on the ";6S! and highlight the whole profit set9up in a new chart of ";6S! below.
The 2ib is kept in the same place, so we have an up trend between Kune and 'ug with a retracement
to the end of 'ug. To calculate profit targets we can use 2ibonacci "xtensions. The most common
of which are $.=F< and $.L&F.
We use T$e ;H#D "ibonacci pattern to establis$ our trading strategy. The start point of our
2ib is labelled ', while the end of the 2ib is labelled : N ThatMs the easy bit. 3ow it gets a wee bit
harder as we need to establish our trade entry point. If we have established weMre in a trend and
weMve recogni(ed the down turn is a consolidation period prior to the trend continuing then we need
to find our entry point 0The section ;etracement or ;eversal N a Ahecklist, in this module should
help here1.
In or example, using 2ib retracement, the ";6S! retraces back to #$% on <>th 'ug with a
stochastic oversold signal. We could have entered here, or we could have entered on the =&st 'ug
or &$th Sep. 't both these later dates the #$% retracement $as been confirmed@ indicating
support. In our example entry was =&st of 'ug as a double bounce on support is good
confirmation that support will hold 0volumes can help here where buying pressure will increase on
support N not shown. SM' will also help confirmation1. This 4ong 0:H1 entry point is our A
point. Be aware of support and resistance levels and trading channels, as your profit targets
could be affected be these.
";6S! 9 2ibonacci "xtension to Set )rofit Targets
7ur profit target needs to be set now. This is where 2ib "xtensions come into play. Some software
applies these automatically, but others you will need to edit yourself. sually you can edit the
properties of 2ibonacci to achieve this. HouMll see on our example IMve had to edit the 2ib with a
9=F.<, 9#$ and NL&.F to get the extensions N these are our $.=F<, $.#$ and $.L&F extensions. Hou can
calculate the 2ib extension yourself by the following formula where ' T the &$$% retracement and
: is the $% retracement.
p tend+ ! T : E W0:9'1 x 2ib "xtensionX !owntrend+ ! T : N W0'9:1 x 2ib "xtensionX
6mportant& Some traders will calculate from ; meaning our ./4,5 extension becomes ,/4,5 9
Bust be aware of t$is w$en loo7ing at ot$er resources/
In our ";6S! example our profit target at ! occur on &>th 7ct. If our entry point is #$%
retracement, our target should be #$% extension 0or &.# in some software1. The same applies for
=F.<% and L&.F% etcS We could have reduced our expectations here and taken profit at the =F.<
extension, which would have also been profitable. ItMs almost like a self9fulfilling event, as most
technical traders will be looking at the same stand out 2ibonacci to profit. The #$% extension was
hit on the button, prior to profit taking. 3otice how the 2Y pairing hits the L&.F% extension exactly
prior to a reverse 9 This has now become an important resistance level as can be seen to the far right
of our chart.
Example "ibonacci Trade
2ibonacci Simple Trend Trade 0sing above ";6S! chart1
!raw 2ib and get 2ib retracement confirmation 0see above1
Aonfirmation set at point 0A1
)rofit Target 0!1 is #$% 0or &.#$1 extension line
Stop64oss placed either at next 2ib level below entry point 0in this case L&.F%1. This allows
the trade to breathe, but may be a little to much for some. It all depends on your risk
threshold. ' longer term trader may place the stop way back at the &$$% retracement, while
a day trader may place the stop under the last candle bottom
;isk6;eward. If target is ! 0&.>&1, entry 0A1 is &.<L and you lace a stop at &.<># 0under
L&.F%1 your risk reward is profit 0!190A1 T $.&# 6 potential loss 0A19Stop T $.$&# T &$+&.
Set trailing stop under trend line, moving averages of below the last candle low.
"ibonacci Extensions - "uture Support and Fesistance
's indicated in the above paragraph, 2ibonacci extensions can form important support and
resistance levels for future price action. 's seen in the above ";6S! currency pairing chart the
3ovember high at extension level L&.F% now becomes resistance for future price moves in Kanuary
<$&&. Support and resistance levels can be seen along the length of the extension as we go ever
higher. 2or instance the &.=F<% 0or <.&=F%1, &L&.F% 0or <L&.F%1, etc.. may also become an
important support6resistance level in the future too.
To Sum Dp
The value of 2ibonacci*s numbers is clear to see in nature as well as in finance and should be an
important part of your trading strategy. 's we*ve seen 2ibonacci is a trading tool used by many
Ahartists to anticipate trade entry points as well as setting profit targets and stop6loss positions.
5owever, it*s not an all9in9one trading solution and should always be utilised with other technical
analysis.
There*s a strong relationship between 2ibonacci, human nature and crowd mentality. 7ne theory
that we*ll go on to talk about is The "lliot Wave, which used 2ibonacci as it*s basis. This theory and
the psychology of trading need to be looked at at this point.
Some points to note are+
o *ibonacci ratio retracements don+t always happen, but play around with *ibs to
satisfy yourself of it+s worth to your own trading strategy.
o Be aware of support and resistance levels and trading channels, as your profit
targets will be affected be these too.
o Its best to trade in the direction of the trend.
o ,se -ulti.timeframe analysis, other chart patterns, price action and other tech
analysis for confirmation of trend, entry and e"it.
Pea7 and Troug$ ;nalysis
)eak and Trough 'nalysis is a useful tool to identify when a security is trending or is in a period of
consolidation. Spotting trend is important for trend traders as many trend traders will only trade
when there*s a definite trend to be seen. Trading in a trend tends to let your profits run and is
usually more predictable than range trading. 5owever many traders do trade in ranges and we*ll
study this and other types of trading in future sections. )eak and trough analysis is also useful to
gain points of entry to the trade, especially if combined with other technical indicators. 'gain, we*ll
delve deeper into technical indicators in future sections.
's we*ve seen in our section on !ow Theory price action never goes up or down in a uniform
manner, it (ig(ag*s. This (ig(ag motions forms the peaks and troughs in charts. In an up trend each
new peak is higher than the previously observed peak and each new trough is higher than the last
observed trough. In a down trend each new peak is lower than the previously observed peak and
each new trough is also lower than the last observed trough. This is what defines a trend 9 higher
highs 0peaks1 and higher lows 0troughs1 for the up trend and lower highs and lower lows for the
down trend.
Some charting software will highlights peaks and troughs for traders 0%9(ig(ag indicator1, but
spotting them yourself is possible. To do so, one must bring up your chart focusing on primary
trend and simply highlight all the significant highs and lows. 'fter a while you*ll get used to
spotting them... This should indicate whether you*re in a long term trend, or not. Hour primary trend
is determined by your trading hori(on, i.e. if you are a day trend trader 0in and out of a trade within
a day or thereabouts1 you may want to focus on a primary trend of a few months. ' trend traders
will then usually only trade in the direction of the long term trend.
In our 2orex example of the S!6K)H cross9pairing, a down trend looked like it had started in May
<$&$ and finished in 3ov <$&$, but by highlighting the main peaks and troughs with arrows we can
see the circled red arrows indicated there weren*t lower lows until Kune <$&$. The down trend
actually started in Kune <$&$ with consecutive lower highs and lower lows. Trend trading would
have been difficult prior to Kune <$&$, as technically the price may still have been in a range.
)eak and Trough 'nalysis
Aombining )eak and Trough 'nalysis with other trend spotting technical indicators like moving
averages is '4W'HS wise in forming trading strategies. It*s also wise to make sure the timeframe
isn*t too short, so remember to use Multi9Timeframe 'nalysis to figure out the markets general
direction.
:e aware that if the trend 8ourneys into a consolidation range, it can do so for .uite some time. In
general a range can last between ==% and LL% of the length of the trend, but not in all cases. !on*t
be fooled thinking that the trend will reverse after this consolidation period either. The trend can
continue on it*s merry way after this consolidation. We*ll go on to talk about consolidation chart
patterns in later sections.
It$er :et$ods of Spotting Trend
Some define trend as a deviation from a range as indicated by Hollinger bands. 2or others, a trend
occurs when prices are contained by an upward or downward sloping ).-period :o!ing ;!erage.
7thers will utilise The 'verage !irectional Index 0;DJ1 to identify trend. 'll of these indicators
can be found under Module = in our course.
Trend Traders
;egardless of how one defines trend, the goal of trend trading is the same 9 Boin t$e mo!e early
and $old t$e position until t$e trend re!erses. The basic mindset of trend trader is PI am right or I
am out-P The implied bet all trend traders make is that price will continue in its present direction. If
it doesn*t there is little reason to hold onto the trade. Therefore, trend traders typically trade with
tight stops and often make many probative forays into the market in order to make the right entry.
:y nature, trend trading generates far more losing trades than winning trades and re.uires rigorous
risk control. The usual rule of thumb is that trend traders should never risk more than <% of their
capital on any given trade. Module I has more on Managing Money
6ntroduction
Many of the most successful traders will only trade when there*s a trend present and some like to
catch the new trend early on the reversal. Whatever the trading style, all traders need to know the
difference between a trend retracement and a full9blown trend reversal.
We*ve gone through some of the indicators, chart patterns and talked support and resistance already,
but 7nowing retracement !ersus re!ersal is a must. Whether you*re looking to use 2ibonacci,
Moving 'verages or Trend 4ines as part of a trend following strategy, or looking for the reversal,
then itMs worthwhile identifying whether the change in a trend is a correction or a complete turn9
around.
Traders thus face the following dilemma+
If they*re in a position relying on the trend continuing, do they hold onto their position- $his
could lead to losses if the retracement turns out to be a longer term reversal.
They could close their position and re9enter if the price starts moving with the overall trend
again. /f course there could be a missed trade opportunity if price sharply moves on.
-oney is also wasted on spreads if you decide to re.enter.
They could close the position permanently. $his could result in a loss 0if price went against
you1 or a huge profit 0if you closed at a top or bottom1 depending on the structure of your
trade and what happens after.
:ecause reversals can happen at any time, choosing the best option isn*t always easy. This is why
using trailing stops can be a great risk management techni.ue when trading with the trend 0See the
Module on ;isk Management1 . Hou can employ it to protect your profits and make sure that you
will always walk away with some pips in the event that a long9term reversal happens. In our
Moving 'verages and )arabolic S'; section 0amongst others1 we*ve explained some trading
examples utilising the trailing stop.
Fetracement or Fe!ersal - T$e Difference
In a retracement or correction the long9term trend is still intact, so if you gambled on a full9blown
reversal it could have been a costly trade. ItMs important to know the difference between the two, as
this will influence our decisions to hold, sell or buy the security with a view to picking it up later
on.
; retracement is defined as a temporary price movement against the established trend. 'nother
way to look at it is an area of price movement that moves against the trend but returns to continue
the trend.
Fe!ersals are defined as a change in the overall trend of price. When an uptrend switches to a
downtrend, a reversal occurs. When a downtrend switches to an uptrend, a reversal also occurs.
Fetracement or Fe!ersal - ; #$ec7 list
There are key differences between the reversal and retracement as highlighted in the following
check list.
Retracement or
Reversal Check
list
Retracement / Correction Reversal
Volume Small Selling Volume Large Selling Volume
Money Flow Buying Interest during decline is
still present and selling interest in a
up trend is still present
Buying interest is small in a
down trend and selling
interest is small in up trend.
Both force price to reverse
Chart Patterns Continuation Patterns !edges"
#riangles" Flag $ Pennant%
&eversal Patterns 'ead $
Shoulders" (ou)le #op%
#ime Frame #hey are short lived #hese are Longer #erm
movements
Fundamentals *o Change Change or Speculation of change
Candlestic+s Lots of Indecision Candles with
long shadows and small )odies
&eversal Candles lic+ engulfing"
soldiers etc,
This list is by no means fool proof, but give a trader a base for understanding the corrective nature
of a market. Kust remember to be aware of the time frame you*re dealing in. ' weekly chart
looking out # years may see a retracement, but that very same retracement may be a reversal on a
daily chart 9 ;emember time9frame analysis.
6dentifying Fetracement
There are a few ways to identify retracements other than the checklist above. These are+
&. 2ibonacci ;etracements
<. )ivot )oints
=. Trend 4ines
>. Aandlestick )atterns
,/"ibonacci Fetracement
' popular way to identify retracements is to use 2ibs. 2or the most part, price retracements hang
around the =F.<%, #$.$% and L&.F% 2ib level before continuing the overall trend. 6f price goes
beyond t$ese le!els@ it :ay signal t$at a re!ersal is $appening. 's you may have figured out by
now, technical analysis isn*t an exact science, which means nothing certain...
2or an in depth look at 2ibonacci ;etracement see our section earlier in the Module.
)/Pi!ot Points
'nother way to see if price is staging a reversal is to use pivot points 0intra9day only1. In an
uptrend, traders will look at the pivot or lower support points 0S&, S<, S=1 and wait for them to hold
or break. If broken, a reversal could be in the makingZ In a downtrend, traders will look at the
pivot / higher resistance points 0;&, ;<, ;=1 and wait for it to hold or break.
)ivot )oints 9 ;eversal or ;etracement
1/Trend ines
The last method is to use trend lines. When a ma8or trend line is broken, a reversal may be in effect.
We*ve already looked at how to draw trend lines, how support and resistance can affect trend and
how moving averages can act as trend lines, so if you*re unsure then please revisit the relevant
section.
2/ #andlestic7 Patterns
:y using trend lines in con8unction with candlestick chart patterns discussed in Module #, a trader
may be able to get a high probability of a reversal.
To Sum Dp
Hou now have the tools to try to differentiate between a retracement and a reversal. Dsing t$e
K#$ec7 istK and t$e K6dentifying FetracementK section will gi!e you a fig$ting c$ance.
While these methods can identify the difference between retracements and reversals, they aren*t the
only way. 't the end of the day, nothing can substitute for practice and experience. With enough
trading time, you can find a method that suits your trading personality in identifying retracements
and reversals.
;eversals can happen at any time. ;etracements can turn into reversals without warning. This
makes using trailing stops very important. With trailing stops, you can effectively prevent yourself
from exiting a position too early during a retracement and exit a reversal in a pinch.
T$e Hullis$ Engulfing Pattern
Trading wit$ Engulfing Patterns - by Fic$ard Lri!o
What .ualifies as an engulfing candle is fairly simple+ as long as the body of a candle engulfs the
previous candle in terms of the body and wicks, it would be considered an engulfing candle
0Sometimes you may find trader*s don*t count the wicks1. 's such, it can indicate that a move in the
opposite direction of the candle that was QengulfedRmay take place.
In other words, if a bullish candle is engulfed by bearish candle, the higher probability direction to
trade the pair will be to short it. If a bearish candle is engulfed by a bullish candle, the higher
probability direction to trade the pair will be to buy it.
;emember, 8ust because a trader sees an engulfing candle does not mean that a move in the
opposite direction is assured. 's far as being certain goes, a trader can be certain that a candle is an
engulfing candle, but we can never be certain of what may transpire on the chart going forward.
Veep in mind, as is the case when interpreting candlesticks, a trader cannot make a decision
regarding what a candle might turn out to be until that candle is closed. So, always wait for a
candle to close before making a trading decision based on whether it*s engulfing or not.
; simple trading strategy is to take a trade when the engulfing candlestick is in the direction of
the main trend. In other words, in a correctional take profits retracement we would look for bullish
engulfing candles and in a short bullish correction we would look for bearish engulfing candles.
Should the trade be taken, the stop can be placed below the bullish engulfing candle in an uptrend
and above the bearish engulfing candle in a down trend. See more on stop6losses in our Module I
4astly, as usual, nothing in trading is a certainty and not all engulfing candlestick patterns will lead
to a reversal. Testing a system with proper risk management is essential prior to trading
;eally only useful if found in a downtrend. We can see the pattern on the left above where the
hollow candle body completely engulfs the filled candle body. This pattern doesnMt indicate
indecision, but that buyers are bac7 in t$e mar7et 9 The short bear candle is running out of steam
and being engulfed by a strong long bull candle. The longer the white 0hollow1 candle against the
black 0filled1 candle the greater the chance of reversal and if there is increased volume weMll also
increase our chances of a reversal. The black candle shouldnMt really be a do8i as itMs fairly easy to
engulf. If the shadow is engulfed, then this is better, but not necessary and finally the shadows on
both candles should be small or non9existent. 'gain, further confirmation is needed for reversal.
This pattern can also confirm a continuation of trend and continued buying pressure. If seen
passing through a resistance level then this may confirm a break of resistance. This pattern is valid
as long as the body is engulfed.
T$e Hearis$ Engulfing Pattern
Inly useful in an up trend and is the exact opposite to the bullish engulfing pattern N it is the <nd
diagram on the left above. The same rules apply here as they did above and we should always look
for other confirmation in the form of further price action to the downside 0like the three black
crows, below1 and increased downside volume.
T$e Piercing and Dar7 #loud #o!er Patterns
These two blends work in the same ways as the previous two. The )iercing pattern is a bullish
pattern where the hollow <nd candle drives up from below the previous filled candle to above half
way of the previous filled candle. :oth candles should be fairly large bodied with small shadows. If
the white candle doesnMt finish above the black candles middle then this isnMt considered bullish.
This is the third diagram above. 'gain, confirmation is re.uired for reversal. !ark Aloud Aover is
the mirror image of The )iercing )attern.
T$ree C$ite Soldiers and T$ree Hlac7 #rows Fe!ersal
Solid Aonfirmation is found if reversed momentum is followed up with strong corroboration N the
most famous of these are the three white soldiers and the three black crows. The = white soldiers
e.ual & long white 0hollow1 candle and the = black crows e.ual a long black6red 0filled1 candle.
Hot$ t$ese blends can be seen in re!ersal patterns and are used to confirm t$at t$e re!ersal
$as ta7en place.
These two formations will be more prevalent after a long trend that is going through a reversal.
Ideally the = candles should start within the last candle and close near the high 0in the case of the =
white soldiers1 or the low 0in the case of the three black crows1. In the = white soldiers chart below
the soldiers are the reversal and in the = black crows chart the black crows confirm a spinning top
candlestick showing indecision.
Three White Soldiers / three :lack Arows ;eversal
T$e Dse of It$er Tec$nical ;nalysis is Heneficial
Aandlesticks provide an excellent means to identify short9term reversals, but should not be used
alone. 7ther aspects of technical analysis can and should be incorporated to increase reversal
robustness. 2or instance support and resistance, 2ibonacci retracement and overbought and
oversold oscillators can play an important part in any price action trading strategy. 4ook how
support coincides with a bullish engulfing candlestick pattern and how The Stochastic crosses the
bullish #$ line below helping to confirm the reversal.
"xample of )rice 'ction Aombined with other Technical 'nalysis
How to Trade #andlestic7 Fe!ersal Patterns
's we*ve discussed in all of our Aandlestick ;eversal )atterns, traders must wait for confirmation
prior to trading. This means that they*re supposed to wait until t$e following day?s close to see if
t$e stoc7 re!erses. This is the trade entry point. Aombining candlestick confirmation with other
technical analysis, i.e, oscillators, moving averages etc...to gain further confirmation may also be
prudent as we*ve seen above. 5owever If a stock pulls back to an area of demand 0support1 and
there*s a candlestick pattern telling us that buyers are taking control of the stock, then that is all the
confirmation some traders need. The choice is yours and all depends on your threshold for risk.
4et*s look at an example trade using the engulfing candlestick pattern. This is a simple day trading
system for example only, using the '!6S! forex pair, so you may want to research other price
action6indicator systems. Hou also need to back tested all trading systems yourself, to make sure
your comfortable with the risks. :ut I hope you can see how this system can transfer to other
candlestick patterns and time9frames-
"xample :ullish "ngulfing6Moving 'verage Trading System
7ur set up 9 a & hour chart with a #$9period simple moving average
7ur system rules 9 If price is above #$ SM' we*re in an up trend so we buy. In an up trend we*re on
the look9out for bullish engulfing candlesticks. In a down trend 0price below #$ SM'1 we look for
a bearish engulfing pattern and we sell.
"ntry 9 & pip above the high of the bullish engulfing or & pip below the bearish engulfing on the
next candle
;isk Management 9 Stop64oss placed & pip below the bullish engulfing in an up trend, or & pip
above the bearish engulfing in a down trend
Take )rofit 9 We*re looking for a reward to risk ratio of &+&.
So, )rice is above #$ SM', so we need to be looking to go long. I*ve highlighted the bullish
engulfing candle in the yellow oval on our & hour chart. We enter long & pip above the bullish
engulfing candle on the next candle at &.$#=$ 0=am, &Lth Mar1 and place a stop6loss at &.$#$F. If
our Target take profits ratio is &+& then our target price is &.$##< 0i.e the e.uivalent distance from
entry to our risk 9 &+&1. We reach this at &pm on the &Lth 9 &$ hours later.
Well, I hope you get the 8ust of how to trade candlestick patterns and begin to see how you can
develop your own system- 7f course many trades will go against youZ ;emember this is a simple
system. Hours may incorporate different reward to risk factors and support and resistance etc... See
the Trading 2lowchart for more ideas. :ut you may want to keep it simple 9 Simple systems do
make money. Oisit some blogs and sites to view some other systems.
Technical analysis is not an exact science and although these ideas can increase the probability of
making the correct trade, many will go against you and large losses can be incurred. Hour own
trading strategy needs to be formed and hopefully you*ll be on your way to achieving this on
completion of this course.
6ntroduction
Daps in charts are empty spaces between one trading period and another. They usually form
because some information 0exceptional earning report, profit warnings, mergers etcS1 has come to
light. :asically the opening price of the <nd period moves substantially away from the &st periodMs
closing price in post and pre9trading. 6t8s often said t$at Egaps will always fillG@ meaning t$e
price will mo!e to co!er t$e gap sooner rat$er t$an later. This doesnMt always happen, or may
take some time to happen. These fills are .uite common and occur because of the following.
"xuberance+ The initial spike may have been overly optimistic or pessimistic, therefore
inviting a correction.
Technical ;esistance+ When a price moves up or down sharply, it doesn*t leave behind any
support or resistance
)rice )attern+ )rice patterns are used to classify gaps, and can tell you if a gap will be filled
or not. We explore these gap types below. "xhaustion gaps are typically the most likely to
be filled because they signal the end of a price trend, while continuation and breakaway gaps
are significantly less likely to be filled, since they are used to confirm the direction of the
current trend.
'ap Types
There are > gap types as highlighted in the following chart. Ahartists will look at trend, volume and
location of the gap when forming their trading decisions. The bullet points below the charts
highlight the important aspects of the period gaps.
5ere are the key things you will want to remember when trading gaps+
7nce a stock has started to fill the gap, it will rarely stop, because there is often no
immediate support or resistance.
"xhaustion gaps and continuation gaps predict the price moving in two different directions 9
be sure that you correctly classify the gap you are going to play.
Make sure to wait for the price to start to break before taking a position.
:e sure to watch the volume. 5igh volume should be present in breakaway gaps, while low
volume should occur in exhaustion gaps.
T$e 6sland Fe!ersal
The above Dap types can be found in specific Dap ;eversal )atterns. 7ne of the most well known
gap formations is the Island ;eversal. This reversal pattern is formed by a gap followed by flat
trading period, then confirmed by another gap in the opposite direction. This can be found in an up
trend or down trend and can be seen in the below chart.
The Island ;eversal )attern
The above Island ;eversal is formed after an up trend. 'n exhaustion gap appears, followed by a
consolidation, then a breakaway gap down. T$e quality of t$e re!ersal signal and t$e strengt$ of
t$e subsequent re!ersal are more robust if it comes at t$e end of a long trend. 3otice volume
too. T$ere8s large !olume going into t$e ex$austion gap and large !olume going into t$e
brea7away gap.
Trading 'aps - ; Day Traders Perspecti!e
P2adingP occurs when gaps are filled within the same trading day. 2or example, a company reports
good earning, and price gaps up on daily open 0meaning it opened significantly higher than its
previous close1. 's the day progresses, traders realise that some not so good news is hidden within
the depths of the report, so they start selling. "ventually, the price hits yesterday*s close, and the gap
is filled. Many day traders use this strategy during earnings season or at other times when irrational
exuberance is at a high.
:ore on Trading 'aps - Some Popular Systems
There are many ways to take advantage of these gaps, with a few more popular systems highlighted
below+
Some traders will buy when technical*s favour a gap on the next trading day. 2or example,
they*ll buy a stock after9hours when a positive earnings report is released, hoping for a gap
up on the following trading day.
Traders might also buy or sell into highly li.uid or illi.uid positions at the beginning of a
price movement, hoping for a good fill and a continued trend. 2or example, they may buy a
currency when it is gaping up very .uickly on low li.uidity and there is no significant
resistance overhead.
Some traders will fade gaps in the opposite direction once a high or low point has been
determined. 2or example, if a stock gaps up on some speculative report, experienced traders
may fade the gap by shorting the stock.
4astly, traders might buy when the price level reaches the prior support after the gap has
been filled.
To Sum Dp
Femember@ gaps are ris7y 0due to low li.uidity and high volatility1. Those who study the
underlying factors behind a gap and correctly identify its type, can often trade with a high
probability of success. 5owever, there is always a risk that a trade can go bad. Make sure you gain
further confirmation through technical analysis prior to trading, i.e studying volume. If you see
high9volume resistance preventing a gap from being filled, then double check the premise of your
trade and consider not trading it if you are not completely certain that it is correct.
6ntroduction
WeMve looked at some reversal patterns involving a series of candlesticks. Some like do8i and long
shadow candlesticks need prior and preceding confirmation to confirm the reversal and some like
the engulfing pattern, three white soldiers and 5arami are patterns in there own right. ;ll of t$ese
patterns@ doBi and long legged candlestic7s are also significant support and resistance
le!el mar7ers.
#andlestic7s #onfirming Fesistance
The same buying and selling pressures apply here as they did in our sections QAandlesticks N The
:asicsR and QAandlesticks and the ;eversalR. The engulfing, 5arami, three black crows, dark cloud
cover, evening star, shooting star, do8i, long9legged, Marubo(u and long filled candles can all mark
resistance levels.
I*ve included a couple of charts below to show some of these candlesticks and patterns forming
good resistance. 's we can see there are :earish "ngulfing, :earish 5arami, Shooting Stars, !o8i,
Spinning Tops, Inverted 5ammer and various long9shadow candlesticks all helping to confirm
resistance. ItMs worthwhile familiarising yourself with these patterns in our glossary. 2otice in our
first chart that a bearish engulfing can also be a shooting star.
Aandlesticks and Aandle )atterns Aonfirming ;esistance 0&1
Aandlesticks and Aandle )atterns Aonfirming ;esistance 0<1
#andlestic7s #onfirming Support
The bullish engulfing, bullish piercing, 5arami, hammer, inverted hammer, morning star, do8i,
long9legged, Marubo(u and long white candles can all mark support levels. IMve highlighted some
of these in the charts below. 3otice in the second chart that the middle section of the chart bounces
along support. We have many do8i and small bodied candles here signifying a neutral stance and
indecision. Aonfirming support can be seen in trends as well as in ranging markets
Aandlesticks and Aandle )atterns Aonfirming Support 0&1
Aandlesticks and Aandle )atterns Aonfirming Support 0<1
To Sum Dp
I hope you can see why the above support and resistance confirmations can be useful. In any
trading strategy it*s important to understand these levels as they can act as important psychological
barriers to price action and offer good entry, stop6loss and exit positions. Why not go over the
importance of support and resistance again-
6ntroduction
In the &GF$Ms Kohn :ollinger developed his bollinger band theory around moving averages.
:ollinger :ands allow us to determine volatility in the market as well as measuring how high6low
prices are relative to their historical price action. :ollinger bands comprise of an upper, lower and
centre band. The centre line in the band is a simple moving average 0SM'1 usually set at <$ periods
and the upper6lower bands represent chart points that are < standard deviations away from the
average. )rice should normally fall within the upper and lower bands. When the bands widen,
volatility increases and when they narrow volatility decreases.
Trend reversals usually take place close to the upper and lower bands and the centre line will
sometimes act as support and resistance 0;em+ ItMs a <$9day SM'1. Many traders use these
bollinger bands to determine o!erboug$t and o!ersold le!elsJ especially in range bound
mar7ets that are said to take place F$% of the time. Price tends to rebound between t$e upper
and lower bands like a drunk bouncing along two alley walls. Hollinger bands don8t produce
signals in t$emsel!es@ but can act as confirmation t$at re!ersal is ta7ing place. 's weMll
discover below in QTrading overbought and oversoldR very often price will QwalkR the band,
especially in trending markets. Traders use :ollinger bands in a few ways+
Identify overbought and oversold
:ollinger :and Aontraction
:ollinger :and Q:andsR
Aombining :ollinger bands and time frame analysis
Trading I!erboug$t and I!ersold e!els
Traders use :ollinger bands to identify overbought and oversold levels. When the price of t$e
mar7et touc$es t$e upper or lower band t$e mar7et may be o!ersold or o!erboug$t/ 6f t$e
price crosses t$e outer Hollinger t$en t$is represents significant o!erboug$t and o!ersold.
These QtagsR and bollinger band crosses are not signals, merely gauges. )rices tend to hug the outer
:ollinger for long periods of time, especially in a trend, so ot$er indicators must be used w$en
using t$em in trading strategies N This is especially true with :ollinger bands over other
indicators.
Trading oversold and overbought levels with :ollinger bands is a good strategy in range bound
mar7ets, while using other indicators and chat patterns as confirmation 0e.g. may be a head and
shoulders touching the bollinger1. To illustrate this weMve drawn a chart of S/) #$$ that has a range
on the right from Mar <$&& and an upward trend on the left. Hou can see that in t$e range bound
mar7et we $a!e multiple touc$es of t$e outer bands and in t$e up trend t$e price $ugs t$e
upper band for much of the time. Aombining the bollinger with another indicator like the ;SI
helps us with our trading strategy N utilising ;SI overbought and oversold signals, ;SI trend I!,
;SI !ivergence6Aonvergence, Aentre 4ine crossover or ;SI failure swings.
,st Fange Trade
In the chart below we have many overbought and oversold levels. Many of them in con8unction
with :ollinger would have been profitable. We have an ;SI !ivergence at 0&1, which we can look
to for possible reversal. 7ur short6sell signal occurs when the diverged ;SI crosses back over the
I$9signal line on the >th May and our exit signal could be when the price hits the opposite bollinger
on the &Ith May. In range bound markets traders may anticipate that the price will move from one
outer band to the other.
)nd Fange Trade
Aombing the :ollinger*s upper touch with a simple ;SI overbought signal at 0<1 could have been a
short trade position. 's the ;SI crosses I$ it signals a sell6short trade. 7ur profit target was the
lower :ollinger band, but we can*t see if it was reached. 5owever, other profit targets can be set.
2or instance, a trailing stop order could have worked here 0trailing price down, until price turns1, or
our target could have been the oversold ;SI =$9level. There are many money management
strategies employed by traders, we*ll talk about these in future modules. ' Stop64oss order here
would have also been extremely useful, as they limit our losses. When dealing with bollinger bands
stop6losses you may want to look at Q:ollinger :and Q:andsRR below.
S%) #$$ 9 :ollinger :and 7verbought and 7versold
7f course there are many trading signals that can be utilised. 'fter the ;SI overbought signals
above traders may wait until a <$9day SM' has been crossed before confirming a trade, or a #$9line
;SI cross may be needed for confirmation. It*s up to you to decide how much confirmation you
need prior to trading. More confirmation means less false signals, but also means less profits if the
trade goes your way.
3otice the strong trend on the left hand side of the S/) chart above. In a strong trend the price
generally fluctuates between the <$9day SM' and an outer band, so a cross of this <$9day SM'
may represent a price reversal. This looks to have happened on the <<nd 2eb above. ' shock has
broken <$9period SM', breaking the trend.
Trading T$e Hollinger Hand #ontraction@ or ESquee<eG
Denerally, after periods of low volatility in the market the market tends to rally significantly. 's
weMve learned in chart patterns, when the bulls and bears cancel each other out volume and interest
begins to wane. When a break does come, it comes significantly. ; contracting bollinger band
Et$e squee<eG@ represents low !olatility and $ig$ !olatility widens t$e bands.
4IM" 9 :ollinger :and Oolatility with :andwidth Indicator
In the above chart we have a contraction in the bollinger band up to I Kan && then a bullish break,
from >.<# resistance, meaning the buyers have won in this situation. We can see the contraction
more easily by adding the :ollinger :andwidth indicator to the bottom of the chart setting it up to
<$ periods and < S! like the bollinger. To determine the direction of break we need to employ other
indicators, like ;SI, Stochastics and volume indicators N where we may be looking for divergences.
5owever, this is a challenging play to makeS
Hollinger Hand KHandsK
:ollinger bands QbandsR were created to form buy and sell signals within the bollinger band
indicator. :asically the bollinger band QbandR measures < bollinger bands N The first with a <
standard deviation 0as normal1 and the second with a & S!, which sits within the <S! :ollinger
band. IMve illustrated this on the below ";6S! chart. :asically the chart shows ";6S! in an
up trend until May &&, then in a range 9 notice the hugging in the up trend. To amend the bollinger
band QbandR you must edit it in your charting software, by changing the standard deviation to & N
this creates the inner band. :y doing this weMve created buy / sell and neutral (one.
";6S! 9 :ollinger :and P:andsP
The :ollinger :and Q:andsR can be utilised by traders who trade the trend and those who range
trade. Trend traders who can enter on oversold oscillator signals like ;SI, Williams %; etc can use
the buy6sell (one to establish exit points. 'n up trend trader*s exit point could be as the price crosses
back below the <$9period SM' centre line, or when price crosses from the buy6sell (one into the &
S! :ollinger band. The red circles in the above chart highlight some exit positions. HouMll see that
there are many of these exit points in a trend, so traders need to use other indicators to form their
exit strategy.
:ollinger :and Q:andsR can be used in range trading too. In our ";6S! chart weMve highlighted
two possible short entry positions with a green circle on the #th May, confirmed with an oversold
;SI I$ crossover 0also circled1. ' cross from the buy6sell (one through the & S! :ollinger signals a
buy or short trade 9 in this case a short. This is perhaps not the best example, as initially the trade is
against the trend and ideally traders need to confirm the trend has ended 0i.e support broken1.
5owever, it does show a trade at work. 'n exit for this trade can be played as in the above
paragraph 9 exiting as the price crosses from the bottom buy6sell (one back across to the neutral
(one. I*ve yellow circled this range exit position.
:ollinger bands can be utilised to form stop6loss decisions. Hou can either have your stop loss
placed 8ust outside the :ollinger band as per position & on our chart, or by measuring the bollinger
&st Standard !eviation band height and measuring the same distance up from the top of the < S!
band 0position < on our chart above1. This prevents us from getting stopped out on market noise.
This may be too risky for some though and it all depends on your own trading strategy. WeMll talk
about stop6loss and money management in Module I.
#ombining Hollinger Hands and ;dBusting T$em
:ollinger recommended making small incremental ad8ustments to Standard deviation multiplier if
you are looking at different timeframes and sensitivities. If we are looking more long term we may
use a #$9day SM' bollinger with standard deviation of <.&J or short term &$9day SM' with &.G
S!. 5e also advocates using :ollinger bands over differing time frames, finding correlation and
trading on these correlation signals.
6ntroduction
The Felati!e Strengt$ 6ndex =FS6> created by Welles Wilder in &GIF measures momentum in a
financial instrument indicating o!erboug$t positions on t$e upside and o!ersold positions on
t$e downside. The ;SI measures this by comparing the si(e of its recent gains to the si(e of its
recent losses as is shown in the formula below. This results in an index number between (ero and
&$$ with centre line at #$. This indicator is then usually placed in a box 8ust below the price chart
and is calculated automatically in any good charting software or online package. ' number above or
below the 0. or 1. respecti!ely is considered o!erboug$t or o!ersold, indicating a possible
momentum change. FS6 in best used in Fange Hound :ar7ets@ but we?ll also see $ow it can be
used in trending mar7ets/
;SI T &$$ minus &$$ 6 0&E;S1
Where ;S T 'verage Dain 6 'verage loss
In charting software you may be confronted with a couple of ;SI options, eg Wilder ;SI. Select the
;SI option and generally the default value is set at &> for longer period time frames 0daily chart and
above1. "ven though Wilder invented Q;SIR the QWilder ;SIR is different as it*s smoothing which is
a different exponential average. :oth can be used and serve the same purpose, but here weMll talk
about ;SI. We wonMt go into the ;SI calculation in any great detail except to say that The ;SI is
based on closing prices and the ;S 0;elative Strength1 part of the calculation is measured over the
last &> periods and is smoothed by exponential e.uations.
Some traders will ad8ust the period as part of their trading strategy N eg if theyMre looking at longer
or shorter timeframes. 4owering the period will increase sensitivity and increasing it will decrease
sensitivity 9 ,. day FS6 will reac$ o!erweig$t positions more easily t$an ).-day FS6. To add
more complexity some stocks will reach =$ and I$ more easily than others. ".g. a tech stock may be
more volatile than a tility. To reduce t$e amount of false o!erboug$t and o!ersold signals@
some traders will increase t$e o!ersold and o!erboug$t parameters to ). and 5./ In fact some
day traders will use <$, F$ and use a < period ;SI to form signals and Swing Traders 0Aapturing
gains in securities within a & to # day window1 may look at an ;SI # to form their signals. WeMll
stick to &> for now until we become accustomed to the ;SI.
How it Cor7s and Trading T$e FS6 wit$in a Fange
's with many oscillators the FS6 wor7s best in a range. This chart happens to be a hori(ontal
range, but ;SI also wor7s well in trending c$annel creating consolidation points before the trend
continues again. 6n strong trending mar7ets t$e FS6 tends to fluctuate at $ig$er le!els@ li7e 2.
to -.. We discuss The ;SI indicator in trending markets in the below section.
's weMve mentioned when the ;SI is below =$ or above I$ the market is oversold or overbought
and traders are going to look for a price reversal at some point. In our below chart weMve plotted the
;SI against a daily chart of The 3asda.. The period weMre looking at is from Mar <$&& to Kul <$&&
and you can see weMre trading in a hori(ontal range with good support and resistance levels. To the
far left 0&1 we have an overbought indicator where The ;SI almost hit G$, then a bearish
retracement. I*ve highlighted several overbought and oversold positions, most signal a retracement
within the channel, but some were false signals, like 0<1 circled in Kune. !espite this oversold
indicator the index continued itMs bearish trend until it hit support at <L$$, when it turned N reversal
and retracement can be a process taking a few signals to happen.
I hope you can see how a trader can use the ;SI in a ranging market- 7ur example is a large =$$
point range, so buying at the bottom of the range and selling at the top of the range looks very
profitable when buying on these oversold signals and selling on overbought signals. When looking
for overbought and oversold stocks traders should first see how the overall market is doing. I.e. if
2TS" is thought to be overbought then drill down into individual stocks with high ;SI readings to
trade.
3asda. 9 ;SI overbought and oversold signals
;SI ;ange Trade 0simple strategy1+
Deneral )arameters set at ;SI 0&>1 on a daily chart
:uy trigger 9 "nter the trade long 0buy1 when ;SI crosses above =$
Sell Trigger 9 Sell when ;SI crosses above I$
Short Trigger 9 "nter the trade short when ;SI crosses below I$
Sell the Short Trigger 9 Sell when ;SI crosses below =$
7ur stop6loss is placed 8ust below support or resistance highlighted by trend lines
;isk ;eward ;atio+ 3enerally traders loo% for 456 or 756. (e'll loo% at ris% reward in later
modules
's always other indicators 0like moving averages1, volume and economic news will help with our
trading strategy. If using an ;SI some traders find it useful to make their trading decisions along
with other indicators like the moving average crossover. ' &$9day and <#9day M' crossover may
be useful when using the ;SI 0&>1. I.e. when the &$9day M' crosses below the <#9day M' and the
;SI indicates overbought this may be a good short signal.
Trading T$e FS6 in a Trend
The ;SI tends to work in a very predictable way in a strong bull or bear market. 6n a strong up
trend t$e FS6 tends to fluctuate between 2. and -. wit$ t$e 2. to 3. FS6 E<oneG acting as
support. These ranges are based on the ;SI &> and will change depending on the ;SI period, the
strength of the trend and the securities volatility.
In our below chart of The S/) #$$ we are showing an upward trending market with consolidation
periods along support. HouMll notice that the ;SI surges above I$ on # occasions and holds itMs >$
to #$9(one .uite consistently. 5owever it did hit =>.>L in 3ov $G. 3evertheless the >$9#$ support
level held for # [ months. This support (one provides Qlower riskR entry points to the market when
itMs in a strong up trend. 3otice how the ;SI dips below the support (one and through =$, once the
market breaks support.
S/) #$$ 9 5ow the ;SI works in an p Trend
;SI Trend Trade 9 always go wit$ trend 0simple strategy1+
Deneral )arameters set at ;SI 0&>1 on a daily chart
p trend :uy trigger 9 "nter the trade long 0buy1 when ;SI crosses above >$ or #$
p trend Sell Trigger 9 Sell when ;SI crosses above F$ or G$
!own trend Short Trigger 9 "nter the trade short when ;SI crosses below #$ to L$
!own trend Sell the Short Trigger 9 Sell when ;SI crosses below &$ and <$
7; , don*t sell and keep long6short position until an ;SI divergence precedes the above sell
triggers.
Set a trailing stop <% behind the trade to lock in profits. We*ll talk trailing stops in later
modules
7ur stop6loss is placed 8ust below support highlighted by trend lines
;isk ;eward ;atio+ 3enerally traders loo% for 456 or 756. (e'll loo% at ris% reward in later
modules
6n a down trend FS6 tends to fluctuate between ,. and 4. wit$ resistance le!els between 3.
and 4./ 'gain, these ranges will change depending on timeframe, ;SI period and the strength of
the downtrend. IMve charted the S!6A52 below showing the resistance level providing entry9level
points of which there are > plus two touching #$. To Trade t$is down trend traders will always
follow t$e trend. Instead of entering at the =$ or I$ signal as they would in a range, t$e entry
point will be as t$e FS6 dips below 4. or 3./ This really depends on how strong the trend is and
what your trading strategy will be. It also depends on your ;SI settings, i.e. an ;SI # will be more
sensitive than an ;SI <$, so the entry trigger will be higher. In the below case I*ve highlighted short
positions as the market dips below #$.
S!6A52 9 5ow the ;SI works in a !own Trend
FS6 6ndicator Di!ergence & #on!ergence
The ;SI divergence / convergence has similar trading properties to The M'A! divergence /
convergence, i.e. if theFS6 is trending in t$e opposite direction to t$e price t$en t$is is an
indication t$at t$ere may be a price momentum re!ersal imminent. 6t?s a trend re!ersal early
warning system. ' Aonvergence is in many cases the forerunner to a bullish price momentum
reversal, while a divergence is thought to be the forerunner to a bearish price momentum reversal.
These moves tend to be more robust w$en t$ey cross t$e o!erboug$t and sold line.
:elow in our FS6 di!ergence chart of S/) #$$ we have shown an example of a bearish
divergence, where the price mechanism shows higher highs and ;SI records lower peaks. These
lower peaks in the ;SI hints that weakening momentum in the upward price push is unfolding and
that price may reverse. We can see this unfold below. 's this divergence is an early warning
0leading indicator1 a good entry point will be the next I$ line crossover after the divergence 9
5ighlighted below.
S/) #$$ 9 ;SI 3egative 0bearish1 !ivergence
FS6 di!ergence indicators wor7 best in ranging mar7ets and can be traded as the P;SI ;ange
TradeP in the P5ow it Works and Trading The ;SI within a ;angeP section. 5owever they can be
used in trending markets. ;emember, always trade with the trend, so in an up trend many ;SI
divergences will signal a retracement 0secondary trend1, where traders can sell long positions 0if this
is part of their strategy1. 5owever, a full blown reversal may result after a divergence starting a new
trend. Trade it as per P 8SI $rend $rade9 in the section PTrading The ;SI in a TrendP . :e careful
though. The divergence doesn*t always show a retracement or reversal. In a strong up trend the
price momentum may still go up.
' bullis$ con!ergence $appens w$en t$e FS6 forms $ig$er troug$s w$ile t$e price forms
lower troug$s/'gain, this convergence is more robust when crossing the oversold indicator at =$.
This convergence suggests that downward price momentum is waning and a change in trend to the
upside is possible. 7ther indicators such as volume decreases, moving average convergence and
support and resistance levels will also be useful in determining momentum shifts.
Trading t$e FS6 - S$ort-term Scenario
!ay traders 0Intra9day traders1 and Swing traders 0& to # day hori(on1 can amend the ;SI from &>
down to <, =, >, # etc... When looking at ;SI 0<1 overbought and oversold positions may only stay
for up to an hour or a day, so itMs really only used for these short9term trades of & to # days. Since
shorter period ;SIMs are more volatile than longer period ;SI*s the overbought and oversold
parameters must be changed away from =$ and I$. 2or instance they may be moved to #9&$ for
oversold and G$9G# for overbought. "ach market and situation will have to tweak these parameters
and some historical profiling will help set them as part of a trading strategy.
:elow is how a Swing Trader may use the ;SI
'nalyse the longer trend using Moving averages, )eak trough analysis, support and
resistance etc...
Deneral rule 9 Trade with the trend
!rill into the market with a &# minute chart
se scanning packages to see where ;SI is crossing signals
Set at ;SI 0#1 on the chart. ;emember the ;SI # is more sensitive than ;SI &>
:uy trigger 9 "nter the trade long 0buy1 when ;SI crosses above =$ or >$
Sell Trigger 9 Sell when ;SI crosses above I$ or F$.
7r buy, sell vice9versa if in a down trend
If there*s ma8or resistance prior to this trigger, then sell
' stop6loss is placed 8ust below support or resistance highlighted by trend lines. This could
be no more than a <% loss.
;isk ;eward ;atio+ 3enerally traders loo% for 456 or 756. (e'll loo% at ris% reward in later
modules
This se.uence will be a part of their over all trading set9up and strategy.
To Sum Dp
The ;SI is a standard component on any basic technical chart. The relative strength indicator
focuses on t$e momentum underlying t$e security and is a great secondary measure to be used
by traders. It is important to note that the ;SI is often not used as the sole generation of buy9and9
sell signals but used in con8unction with other indicators and chart patterns.
's we*ve seen, we can set the indicators price action sensitivity. The sensitivity of the indicator
determines how .uickly the trader enters the move and how accurate these trading signals are. If the
indicator is set to low sensitivity then you generate less false signals, but you may see the move too
late, or not see it at all. With high sensitivity you are more likely to catch the move into the trade,
but you may generate false trading signals. 2or instance a swing trader 0trading with a hori(on of >
to # days1 may set the ;SI to =or # once they*ve drill down to an hourly chart from a daily chart.
Dood charting software will allow the parameters to be changed.
osted on May <F, <$$G at &G+>< in Trading !esk by ;yan 7*VeefeAomments 7ff
S!6A52 has been testing U&.$F$ all week and printing an inverted megaphone pattern on the four
hour chart. TodayMs daily candle printed what could almost be considered a bearish engulfing range
but itMs not text book. I reali(e the candle patterns are usually used to time reversals in an uptrend
but it can also have merit as a trend continuation indicator also. IMm wondering if U&.$F$ is going to
give way tomorrow morning with the Swiss V72 data followed by the .S. D!) numbers on the
docket. I went looking on a longer term chart to see what might be holding up S!6A52 at U&.$F$
and this is what I found.
I have an idea how to play this but I need to wait a bit longer before I make any moves. Stay tuned
and best of luck.
;yan
Swing and a Miss
)osted on May <F, <$$G at I+># in Trading !esk by ;yan 7*Veefe> Aomments \
4ooking back on my S!6K)H thoughts I underestimated the strength !ollar would en8oy. It seems
the risk appetite eased enough to send this pair much higher than I thought it would overnight. I was
stopped out on my small sell position but that is fine. Sometimes you swing and you miss, itMs the
nature of the business.
:ack later tonight with my regular long term analysis. I hope your having a great trading weekZ
Kapan Sees Aontinued Improvement
)osted on May <I, <$$G at <$+>L in Trading !esk by ;yan 7*Veefe& Aomment \
!ollar sentiment seems to be improving tonight against the Hen with a rally up to UGL. The !ollar
is challenging the lower boundaries of &GthMs !o8i. ;etail sales data out of Kapan tonight post a
better than expected 9<.G% loss versus the anticipated 9=.<% loss.UGL.$G marks a =F.<% pull back
from the down trend which broke the head and shoulders pattern on this pair. 4ooking at the daily
and weekly time frames I still think UGL is a decent pivot back to the downside on this pair. IMm
testing the waters with a small short at UG#.G$. I suspect if IMm wrong IMll get stopped out by the end
of 3ew Hork tomorrow, guess we will see. ;egardless of potential support at UG> the plan for now
is still the same, targeting UG<.I$ or lower.
Stay tunedS
IM)7;T'3T 37TIA"+ These comments are for information purposes only. My opinions or other
information contained in this post do not constitute investment advice. It should not be understood
as a direct recommendation to buy or sell any currency contract or other investment vehicle. 2orex
trading involves substantial risk of loss and is not suitable for all investors.
Missed it by an InchS
)osted on May <I, <$$G at I+#> in Trading !esk by ;yan 7*Veefe< Aomments \
5aving missed my short orders by 8ust a few pips overnight IMve decided to pull the orders off the
desk. S!6K)H has support on the !aily chart around UG> 6 UG=.#$ which I failed to notice last
night. IMm thinking this pair may be headed a tad higher after all, perhaps the sell is closer to UGL.
"ither way since IMm not L$ pips in the money this morning IMve decided to sit this out for now.
Stay tunedS
Selling )ivot for S!6K)H-
)osted on May <L, <$$G at &F+>F in Trading !esk by ;yan 7*VeefeAomments 7ff
5owdy folksZ
So e.uities rally, !ollar gets beat up and S!6K)H is boring to watch as usual but it looks like the
short idea I talked about yesterday may be getting closer. Tonight IMm watching the support pivot at
UG#.L$ which gave way last week. This has been a decisive area of support on the daily chart over
the last few months and now we are going to test it from below.
3ow comparing that to what I see on the four hour chart, I like the idea of selling around UG#.L$.
Ideally I can 8oin the daily chart head and shoulder breakout at a bargain price on itMs way to a lower
support level.
IMm planning a short at UG#.L$ but if things go horribly wrong IMll be stopped out around UGL.L$.
See the daily chart below for my longer term target on this trade. IMd like to see the pair fall back to
support and a L&.F% pull back around UG<.I$. ;isk to reward is 8ust shy of &+=.
Stay tunedS.
IM)7;T'3T 37TIA"+ These comments are for information purposes only. My opinions or other
information contained in this post do not constitute investment advice. It should not be understood
as a direct recommendation to buy or sell any currency contract or other investment vehicle. 2orex
trading involves substantial risk of loss and is not suitable for all investors.
Memorial !ay :reak
)osted on May <#, <$$G at &=+>I in Trading !esk by ;yan 7*VeefeAomments 7ff
5owdy 2olksZ
ItMs a beautiful day on the lake todayZ Alear skies, I$ degrees and a holiday weekend in the Seattle
area, you canMt ask for much betterZ I hope your having a great day in your corner of the globeZ
The holiday weekend in the nited States has obviously dried up the market activity so today IMm
8ust doing some week ahead planning on the ma8ors.
DSD*EDF
2iberMs assault against the !ollar was unforgiving last week as "uro posted five straight days of
gains. 2rom a technical view the pair has moved into a weekly (one of rather messy supply and
demand levels and it will be interesting to see if the rally can continue unabated this week. AAI on
weekly and daily time frames are oversold but that doesnMt mean the trend is done. 2or now IMm
sticking with the trend and planing to buy on a pullback if the right opportunity comes around this
week. I think U&.>< is in the 2iberMs sights but IMd like to see a pull back and 8oin up with some
bargain hunters.
DSD*MPY
!ollar sold off .uite smartly following the pullback day we talked about last week. There is a lot of
fundamental data on tap for Kapan this week including 8obless data, retail sales, consumer prices and
their trade balance. If the numbers continue to suggest continued stabili(ation and the potential for
expected growth the Hen could continue itMs assault against the !ollar. It also appears talk of
intervention was a false fear last week as well. 's usual, IMm interested in selling with bargain
hunters around the UG#.L$ level if the right opportunity comes along this week.
ThatMs enough shop talk for today, it is time to have some fun on the lakeZ
S!6K)H 2inishes a )ull :ack
)osted on May &G, <$$G at &F+>I in Trading !esk by ;yan 7*VeefeAomments 7ff
!ollar 6 Hen appears to have completed a pull back move on the consolidation that broke out last
week. TodayMs demand level ended up between UGL.#$ and UGL.LG which may offer a nice level to
short through a test of yesterdayMs high. ' short would have to be protected above UGL.F$ as the
pattern breaks down with a close back inside the triangle. UGL.$$ seems to be holding as a pivot
level for now.
!ollar Selling Aontinues 'gainst the Hen
)osted on May &#, <$$G at &$+#$ in Trading !esk by ;yan 7*Veefe< Aomments \
So yesterdayMs guess !ollar 6 Hen would continue to fall was correct. The sell off unfortunately
happened early leaving my orders in the dust. I was looking for a test of WednesdayMs demand level
high before a fall, oh well.
ThatMs all for this week, IMll be back on Sunday looking for some gap opportunities to tradeZ
:est of luck,
;yan
S!6K)H :reaks 4oose, 4ooking to Sell
)osted on May &>, <$$G at &I+=I in Trading !esk by ;yan 7*VeefeAomments 7ff
!ollar 6 Hen finally broke through daily chart consolidation with some gusto yesterday which
brings into play previous support between UGL and UGL.#$. If these previous support (ones provide
resistance the pair may give us some selling opportunities into our new found daily chart down
trend.
sing some simple 2ibonacci it appears the next support targets with price action confirmation
could be UG>.<I 0#$%1 followed by UG<.#$ 0L&.F%1.
:est of luck,
;yan
5ow 2ar Will S!6A'! )ull :ack-
)osted on May &&, <$$G at &I+=G in Trading !esk by ;yan 7*VeefeAomments 7ff
Kust a few posts ago I wondered whether or not S!6A'! would make it down to U&.&# and low
and behold, the pair turned right around on the U&.&# mark.
QIs S!6A'! 5eaded 2or U&.&#-R
3ow IMm pondering how far the pair may pull back before this daily chart trend continues. Thinking
out loud for a moment IMm going to keep my eye on the U&.<$ handle which is right above a L&.F%
pull back and corresponds with broken support back on >6=$.
I think itMd be slick to get a bearish reversal day somewhere in that (one.
What do you think about this pair-
Trading Sunday 'aps
'fter 2ridayMs huge !ollar fire sale I went looking for some gap trade opportunities Sunday night.
Trading gaps on Sunday can be a great strategy for folks who work a day 8ob. They seem to appear
fre.uently now with the marketMs added volitilty, that may not last but it is fun for now. This wasnMt
the cleanest trade IMve ever done but I managed to book a few points off S!6A52.
If you havenMt seen Sam SeidenMs presentation on gap trading IMd recommend taking a look, he has
some great points.
Strong ;etail Sales !ata 2or '!
)osted on May #, <$$G at <&+=I in Trading !esk by ;yan 7*VeefeAomments 7ff
'bout an hour ago the 'ustralian ;etail Sales data posted a <.<% increase versus an expected .#%
increase and the result was a sell off smack into a demand level at U$.I==#. I havenMt dived into the
report detail yet but the number itself is very promising. Trade balance data was better than
expected as well. If you want my opinion I think the initial sell off appears to be technical rather
than a reaction to the data because round number U$.I>$$ was drilled 8ust prior to the sell off. I
suspect some protective stops on any shorts left over from today were tripped above the Q$$] level.
'!6S! has nearly recouped the losses as I write this. 7verall '!6S! had a decent pull back
day within the uptrend yesterday and IMm personally looking for the marked demand level from a
couple days ago to hold up with more than 8ust a touch before I 8oin the trend again.
:est of luck,
;yan
IM)7;T'3T 37TIA"+ These comments are for information purposes only. My opinions or other
information contained in this post do not constitute investment advice. It should not be understood
as a direct recommendation to buy or sell any currency contract or other investment vehicle. 2orex
trading involves substantial risk of loss and is not suitable for all investors.
;ally !ay Within p Trends, 4ooking 2or )ullbacksS
)osted on May >, <$$G at <$+=> in Trading !esk by ;yan 7*VeefeAomments 7ff
5owdy 2olks,
Today was a rally day among most of the daily chart up trends IMve been watching. 2rom reading
this blog you know I prefer to buy into dips during an up trend. Since most of the pairs I watch
made new highs within their up trends, IMm looking for a decent dip day.
There was one exception, S!6K)H had been on a decent rally for the last few daily bars but today
it posted a sell off and lower close. I really looked for an interesting demand level to buy on but I
8ust canMt find anything satisfying about buying S!6K)H until it gets lower. "ven then the rally
may 8ust be a pull back within a larger decline so I reserve the right to be wishy9washy until a
clearer signal appears.
D:)6S! posted about a #$ point bump above U&.#$ today. The .uestion is will U&.#$ hold straight
away headed into 4ondon or will this pair need a deeper pull back before the buyers return-
4ooking over D:)6S! price action I see a couple of areas which may be interesting to watch over
the next trading day. I like the U.&>FL& level better than the U&.>GL$ level but as I mentioned in the
beginning of the post yesterday was an up day in an up trend and IMd prefer a deeper pull back,
perhaps down to U&.>F$$.
D:)6S! is up against some resistance as well so watch out around U&.#$LF which was the high
mark before last monthMs L$$ plus point sell off.
;DD*DSD Nears #$annel Houndaries
We are awaiting the ;oyal :ank of 'ustralia to release their Interest ;ate decision in about two and
a half hours from the time IMm writing this. The ;:' is expected to leave rates unchanged at
=.$$%. This pair has traded inside a channel we have monitored since I started writing this blogZ It
will be interesting to see if the pair is moved lower into demand levels before it can move higher
after the rate statement. I personally donMt think the upper boundaries of the channel will stymie the
pair but you never know. ' break higher may put U.IL$$ and U.IF$$ into play, a reversal and we
look to move back to the lower boundaries of the channel over the medium term.
Finding Fibonacci in various markets
Ni77ei !ersus Dow
The 3ikkei is a widely traded index of ma8or Kapanese shares. It is considered the !ow Kones
Industrial Index of Kapan. Hou would think that since the worldMs ma8or economies are globalised
and inter9connected that the worldMs stock markets would move more or less in synch. 'fter all, a
slowdown in the S' and "urope should result in a similar move in Kapan and Ahina as these
countries are export9driven.
:ut compare the 3ikkei with the !ow on these daily charts going back to the pre9credit crunch
days+
0#lic% on the chart for a larger version1
0#lic% on the chart for a larger version1
2ollowing the <$$I9<$$G collapse, the 3ikkei managed to rally to the exact =F% 2ibonacci level
0blue bar1 N and had declined ever since. That was a great place to short the 3ikkei.
In the !ow, we saw a similar collapse, but the !ow rallied to a deeper L<% 2ibonacci retrace before
hitting resistance. That was also a great place for a short trade. :ut here, the !ow has rallied, unlike
the 3ikkei. Maybe markets are not so inter9connected after all.
4etMs take a look at recent action in the 3ikkei+
0#lic% on the chart for a larger version1
The decline off the 'pril peak is a clear five9wave affair N complete with a positive momentum
divergence at the wave # low. That is pure textbook and indicates the main trend is down.
:ut when you see this pattern, you know a rally lies ahead and it becomes a good idea to cover
shorts.
The first rally carried to the 2ibonacci =F% retrace 0blue arrow1 and after a series of overlapping
waves 0indicating a likely pause in the bear market1, the market made two stabs at the 2ibonacci
#$% level 0blue bars1 and is currently challenging recent market lows.
The rallies to the #$% level were ideal places to enter short trades, of course.
I find that the shallow =F% retraces normally indicate a prompt resumption in the downtrend, while
the #$% and deeper retraces normally indicate more work before the bear market can get back on
track.
EDF !ersus DSD
The euro has been in a bear market for some time, but with a recent large correction.
0#lic% on the chart for a larger version1
2ollowing MondayMs &.<F low N a new low for the move 9 the market this week has rallied in a clear
'9:9A form 0indicating a correction1, and the market made it back to the 2ibonacci L<% retrace
with a slight overshoot 0purple bar1.
These ^pigtailsM are .uite common and usually mark the end of the move.
'gain, a short trade at the L<% area was indicated.
'nd finallyS
'HP !ersus DSD
This market has been swinging wildly recently with no clear direction, and here is the action over
the past few days+
0#lic% on the chart for a larger version1
2rom 2ridayMs high, the decline occurred in five waves+ with a nice positive momentum divergence
at wave #J then a rally to the =L% 2ibonacci levelJ then a dipJ and then a run up to the #$%
level. This last run completed a nice '9:9A 0purple lines1 corrective pattern.
The odds favour a declining market, which would be confirmed by a move below MondayMs low N
and in fact as I write, this move has 8ust occurred in the past minuteZ
In these posts, what I write can very .uickly become out of dateZ
Hou are here+ 5ome 6 2oundations of )rice 'ction Trading 6 Identifying S! _ones N !ecisions and
Multi T2 'nalysis
Identifying SD Zones Decisions and Mu!ti "F #na!ysis
September <, <$&< :y love8oyF$ & Aomment
So far we have learnt+
The concept of supply and demand and how it is the driver of price movements.
The four different types of supply and demand (ones.
What is meant by support, resistance and the familiarities and differences to supply and
demand.
5ow to find supply and demand (ones within an S; (one.
5ow being able to identify S! (ones and key decision levels, can have a significant positive
impact when trading at S; (ones 0in determining entries and stops1.
5ow an untested fresh S! (one has a high chance of re8ection price on the first return.
The more times an S! (one is tested the weaker it becomes as with each re8ection price is
^consumingM supply 6 demand.
The final step in order to understand the basics of price action is to be able to mark up supply and
demand (ones on a chart and determine where price should react within the (one.
The video below discusses examples of marking up supply and demand (ones on the higher time9
frames and then (ooming in to determine where price is ^likelyM to react i.e. where the supply 6
demand 0big money orders1 are situated.
Identifying !emand and Supply _ones by thethetradersguild
Summary
' brief summary of the key points to note from the video are+
To identify S! (ones on a chart we look for the types of (ones outlined in this post.
We should use a top down analysis N start from higher T2Ms working our way down.
What I commonly do is identify a 5&,5>, !aily T2 S! (one and (oom down each T2 to
identify the key decision levels within the (one.
These decision levels consist of a1 clear areas that had to be broken in forming the S! (one
b1 source of the initial move c1 clear untested supply 6 demand N remember we can tell
supply and demand by looking for signs of re8ection from a specific level.
The above can be used to poinpoint with high accuracy where the large orders 0professional
money1 is situated N remember price action trading is all about identifying the large
institutional orders and following them.
The last example in my video was off a trade taken recently on D3_! based on a daily T2 S; N the
chart below highlights where my entry and S4 were placed 0#min T21. The second chart explains
the reasoning behind my entry and S4 levels 0&min T21.
This trade demonstrates how we can pinpoint with high accuracy where price should meet supply
and demand and how we can use this to pinpoint entries and tight S4Ms when trading a re8ection
from an S;. Aompare this to conventional teachings which may tell you+
That touch trading is aggressive and itMs better to wait for confirmation in the form of a bar
or price pattern on a higher T2.
"ntries on touch trades are based on finding the average price between wick extremes within
the S; 0yes people do actually teach this rubbishZ1.
S4Ms should be placed under significant swing high 6 lows below the S; or the S4 should be
placed below the breakout bar low N both of which of course having nothing to do with
where price should react and why.
This of course leads to low trade fre.uency 0always waiting for a pattern to form before taking a
trade from an S;1, missed entries 0because of an entry techni.ue not based on supply and demand1
and wide stops leading to poor risk6reward. ItMs not hard to see why people struggle to good
consistent returns trading through conventional price action teachingsZ
Tired of Heing Too Early or ateO
;ick Wright
Instructor
So youMve analy(ed the charts and have decided that your currency pair is trading at the right
location for a possible reversal N a clear level of supply or demand. The .uestions in the back of
most tradersM minds are, PWill this level hold- 'm I too early-P This is where multiple time frame
analysis can help a trader decide W5"3 to trade. The way I look at the charts is+ My larger time
frame tells me W5";" to enter, and my smaller time frame tells me W5"3 to enter.
' very common problem with new traders is buying or selling too late, or waiting for too much
confirmation. :y the time the moving average has turned, for example, and the trader buys, the
move has already started and your stop loss may be do(ens of pips further out than it had to beZ The
opposite side of buying or selling too late is trading too early. Oery often traders will try to pick
bottoms or tops, yet the price continues and stops them out. ' relatively simple way to fix both
problems is multiple time frame analysis.
2igure &
7n this > hour ";S! chart, the blue arrow indicates the lowest risk, highest reward entry on the
long side. 5owever, many newer traders will be unwilling to take that long trade as the market has
been trending down for the past several days. The fear in this traderMs mind is keeping him from
buying, because of the simple fact that the trend may continue down and hit his stop loss. Waiting
to buy on a close above the upward trending moving average will get him in, but not until &.=FI#.
The experienced trader is looking to the left on the chart and defining his demand (one 0which was
also a supply (one previouslyZ1 from the two dramatic moves to the upside from the &.=IL& level.
This trader will get in, but approximately &$$ pips cheaperZ
3ow the .uestion remains+ 5ow can I get a better entry yet still have confidence that IMm not too
early-
2igure <
sing our multiple time frame analysis, we can see on the &# minute chart that the price action
came down into our demand (one TWIA" within the four hour candle. This even shows us a double
bottom pattern, a very common reversal pattern. So now, waiting for the blue arrow, the trader has a
higher degree of probability in their long trade. Still not enough confidence- 5ow about the do8i
candle with the longer tail, giving a potential bullish reversal- I hope that three reasons to go long at
the blue arrow are enough for youZ If not, then try throwing in a moving average on this smaller
time frame. Waiting for the trend to start will give you more winning trades N albeit with larger
stops and smaller winners. If you waited for the close above the moving average on this chart, you
would still be getting in around the &.=IG$ level N =$ pips higher than the best entry, but about F#
pips better than if you only watched the > hour chartZ
In class, we call this Ptiming our entry.P :uying in high .uality demand (ones and selling in high
.uality supply (ones has been covered numerous times in previous 4essons from the )ros
newsletters. The only potential pitfall in this techni.ue is getting in too early. 5owever, with lots of
screen time, you will begin to trust the levels you have identified. sing the smaller time frame
chart to confirm your entry within your longer time frame supply and demand (ones will lead to a
higher percentage of winners, and give you more confidence in trusting your levels.
7ne simple way to watch these charts is to set up two time frames for the currency pair0s1 you will
be trading.
2igure =
If you are looking at only one chart and switching back and forth between your long9term and short9
term time frame charts, you will certainly miss a trade once in a while. So I do recommend having
two charts of the same pair next to each other on your screen. )rovided your trading computer has
the necessary screen space, why not have these two charts for every pair you trade up at the same
time- Trading from a laptop would make this a bit difficult to see the price action, but if you have a
larger monitor or three, this would be a very efficient techni.ue.
4onger term position traders will often use daily and one hour charts, swing traders may use > hour
and &# minutes, and shorter term may even be using & hour and # minute charts. 'lways keep in
mind that larger time frame supply and demand (ones are more important than smaller time frames,
and this techni.ue should help.
2eb <>, <$&<+ F+&< 'M AST
Though itMs been mentioned fre.uently on the news, the recent crude oil price breakthrough has
been impressive on the charts as well.
4etMs take a look at the current structure of Arude 7il and pay special attention to the breakout from
consolidation6resistance, as well as the current Q7pen 'irR pocket to watch.
Here8s t$e Daily #$art Structure&
I wanted to highlight the main points of the chart, including two trades that developed for
aggressive traders.
2irst, 7il struggled against the U&$= overhead resistance level and formed a clear sideways trading
range 0;ectangle )rice )attern1 between UG#.$$ and U&$<.#$ as labeled above.
This allowed an opportunity to play a QSupport :ounceR 0including the <$$d SM'1 from UG#.$$ as
2ebruary began.
The initial target for a Q;ange )lay off SupportR is always the top of the range or resistance N in this
case near U&$<.#$.
When price broke firmly above the U&$<.#$ line and began trading even higher than that this week
N particularly on the break and close bar on 2ebruary &Ith N it triggered a :reakout trade.
That breakout trade is still in motion, though thereMs no clean6easy entry after the initial breakout
0per breakout trading logic1.
Here8s t$e Pure Price #$art to $ig$lig$t t$e current EIpen ;ir Poc7et&G
The U&$<.#$6U&$=.$$ area was important as it provided prior areas of resistance from mid9<$&& to
present N particularly from May6Kune.
The firm breakout and continuation move higher this week officially enters the Q)ocketR of 7pen
'ir between U&$# and U&&# N thereMs no obvious price resistance between those (ones given the
sharp drop in May.
While price may not continue straight up6directly higher without some sort of retracement, price
may ultimately continue its higher movement towards the prior reversal high at U&&#.
This is the logic of Q7pen 'irR N looking backwards on a chart to see any obvious price targets or
levels. 'n absence of these barriers suggests continued movement through the Q'ir )ocket.R
"or t$ose wis$ing to loo7 inside t$e Daily #$art@ $ere is t$e Hourly #$art Structure&
I wanted to make a .uick note from an educational standpoint, particularly with regard to higher
timeframes.
3ote the UG# confluence support area on the !aily Ahart and now view the structure as it appeared
at the beginning of 2ebruary.
The 5ourly Ahart showed a downtrend developing multiple positive momentum divergences into
the !aily AhartMs confluence support at UG#.$$.
This helped confirm the bigger picture Q;etracementR or Q;ange :ounceR play mentioned above.
"ventually, price broke through the falling 5ourly trendline and developed a QVick97ffR surge in
Momentum N an early chart signal of potential trend reversal.
T$is pro!ides a good example of one of my fa!orite Pcomplex8 trades&
5igher Timeframe Support E 4ower Timeframe )ositive !ivergences6Vick97ff Signal
"ventually, the :reakout Trade developed from this weekMs breakthrough beyond U&$>.$$ and
U&$#.$$, placing us in the current Q7pen 'irR _one.
2or now, letMs watch price in the context of the !aily AhartMs support level near U&$= 0if youMre
bullish, you donMt want to see price return back under U&$= anytime soon1 and the current
impulse6trend move making its way through Q7pen 'irR perhaps all the way back to U&&#.$$ as a
potential target.
#$arting t$e Hrea7down and Ley e!el in t$e #FH 6ndex
7ct >, <$&&+ &+<# )M AST
Aommodities N along with e.uities N have fallen sharply since their respective May <$&& market
peaks.
4etMs take a look at the breakdown in the A;: 0Aommodity1 Index and note the critical confluence
reference support level upon which the index sits currently.
2irst, letMs start with the May peak of =I$. I showed previously that there was a QThree )ushR price
pattern accompanied by a corresponding negative momentum divergence, which was a ma8or
caution sign for the index.
)rice then broke both the <$ and #$ day rising "M's, resulting in a new price and momentum low
0a QVick9offR "arly ;eversal Signal1.
)rice stagnated between ==$ and =#$ for the next few months, though price structure took on a
bearish pattern which confirmed an official trend reversal on the break under =<$ in 'ugust.
The 'ugust breakdown also triggered a close under the rising <$$ day SM', often a Q4ine in the
SandR marker between bull and bear markets 0at least in simplest terms1.
In late September, Aommodities in general collapsed towards the current =$$ target after triggering
a Q:ear 2lagR or breakdown reversal set9up into =>$ 0the underside of the <$$d SM' reference
level1.
2or reference, this is a good example of how a chart9based Trend ;eversal develops and is
confirmed by non9correlated indicators 0QThree )ushR price pattern, negative momentum
divergences, "M' breakdowns along with bearish cross9overs, new momentum low QVick9offR
signal, break under <$$d SM', etc1.
68ll be discussing Trend Fe!ersals in muc$ more detail during two upcoming presentations&
Q!esigned by Traders+ Trading Trend ;eversals Q Ictober ,)@ 1&1. #ST
5ow to Spot and Trade Trend !ays N0when to expect them, how to adapt your tactics6trades to
them1 N at the upcoming 4as Oegas Traders "xpo in 3ovember.
't present, the index trades at the same level as when the 2ederal ;eserve initiated its QInflation9
AreationR program known as ,"< 0,uantitative "asing1.
T$at8s important to 7now as we turn now to t$e wee7ly c$art to see w$y t$e 1.. le!el is a !ery
important index reference le!el&
While you can spot other lessons in the chart above 0the interesting correlation between ,"& and
,"< on the A;: Index, negative divergences and reversals into Kanuary <$&$ and May <$&&1, letMs
focus our attention simply on the two 2ibonacci ;etracement grids overlapping at the =$$ level.
The FED "ibonacci 'rid is the Q:ear MarketR retracement up, starting with the <$$G low and
moving back to the <$$F peak.
The 'FEEN "ibonacci 'rid is the Q:ull MarketR retracement down, starting with the <$&& high
and moving back to the <$$G low.
Hou can also see that the <$&& high into =I$ 0and the negative daily divergences1 developed into
the L&.F% 2ibonacci ;etracement of the :ear Market N very interesting.
C$at8s most important rig$t now is t$e double-confluence Bust abo!e 1..&
The =F.<% Q:ull MarketR retracement at =$L and also ironically the =F.<% Q:ear MarketR
retracement at =$>.
To throw another classic indicator into the mix, the flat <$$ week SM' resides at =$L.#$.
's you can see above, price is nipping under this higher timeframe confluence area which isnMt a
good sign for buyers.
In the meantime, watch the reference support from the 3ovember <$&$ Q,"<] low near <G# along
with the weekly confluence above =$$.
Kust like in stocks, a failure to hold their critical current support reference levels 0see prior posts on
the levels to watch in all stock market indexes1, a breakdown here suggests lower prices will be
seen in both stocks and commodities, so keep all these important levels in mind as you trade this
0and next1 week.
Aorey ;osenbloom, AMT
'fraid to Trade.com
2ollow Aorey on Twitter+ http+66twitter.com6afraidtotrade
AoreyMs new book $he #omplete $rading #ourse 0Wiley 2inance1 is now availableZ
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