How to Analyze and Trade

Ranges with Price Action

by Christopher Vecchio, Currency Analyst for DailyFX.com
cvecchio@fxcm.com & http://www.Twitter.com/CVecchioFX
mboutros@dailyfx.com & http://www.Twitter.com/MBForex

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How to Analyze and Trade Ranges with Price Action

By Christopher Vecchio, Currency Analyst
Heres a secret about trading that seasoned traders will say often, but novices will learn often the painful way: there is no Holy Grail
trading system. No one strategy will catch every single move because any single strategy fundamental, technical, or quantitative can
encapsulate all market conditions. Hence why there are momentum strategies, range strategies, breakout strategies, etc.: each is
designed for specific market conditions.
As a market participant who mainly uses technical and fundamental studies to determine trading entries, I often find that these
perspectives can be in contrast. Because fundamental analysis is rooted in economic data analysis, conclusions reached by analysts
(including this author) tend to be less malleable.
Why is it difficult for fundamental analysts to adjust opinions is it pride? Ego? A good excuse that fundamental analysts use when their
opinion is wrong is, it just hasnt happened yet. That may be a fine attitude to have in the short-term, but at what point do you admit
youre wrong? The question every trader needs to ask themselves is would I rather be right or would I rather make money?
A strong example of why it can be costly to have an opinion and refuse to adjust to changing market conditions is what happened
with the EURUSD between 2011 and 2012. The apex of the financial aspect of the Euro-Zone debt crisis rising Italian and Spanish bond
yields, plummeting equity markets, and concern over the future of Greece in the monetary union drove the EURUSD lower with ease:
EURUSD Daily Chart: April 2011 to August 2012
May

Jun

Jul

Aug

Sep

Oct

Nov

Dec

2012

Feb

Mar

Apr

May

Jun

Jul

Aug

Sep
1.5000

1.4500

08/11-08/12: Correct time to have a bearish EURUSD bias

1.4000

1.36899
1.3000

1.2500

FXCM Marketscope 2014 1.2000

04/15/2011 07/12

08/24

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10/06

11/18

01/02/2012 02/14

03/28

05/10

06/22

08/04

09/04

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For all the aforementioned reasons falling asset prices and legitimate concern over the stability of the governing political parties
having a bearish EURUSD bias was appropriate. There were no formal measures to backstop the regions banking system, peripheral
nations finances were getting worse as borrowing costs rose, and the threat of anti-austerity parties coming to power undermined the
legitimacy of the Euro as a currency the falling exchange rate of the EURUSD reflected this reality.
However, in mid-summer 2012, the game changed. Of course, at the time, in the short-term moment, it was difficult to notice the gravity
of the situation. But time has proved that the situation really did change. The bearish EURUSD bias was immediately inappropriate by the
beginning of August:
EURUSD Daily Chart: June 2011 to January 2013
Jul Aug

Sep

Oct Nov Dec 2012 Feb Mar

Apr May

Jun

Jul

Aug

Sep Oct

Nov Dec 2013 Feb

Mar

1.4500

1.4000

08/12-02/13: Wrong time to have a bearish EURUSD bias

1.36899
1.3000

1.2500

FX
06/03/2011

09/21

11/15

01/09/2012

03/02

04/26

06/20

08/14

10/08

11/30

Marketscope 2014 1.2000

01/28/2013

03/08

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What was the difference? On July 24, 2012, European Central Bank President Mario Draghi said the ECB would do whatever it takes to
save the Euro. Whatever it takes a sweeping, all-encompasing declaration that no matter what happened (unlimited support) was
the crux of the EURUSD rebound.
On the day of the informal announcement, how would a fundamental-based trader know that markets were changing? Did any of the
aforemetioned problems find resolution? No, not in the slightest. Unemployment rates across the region remained (and still remains)
near all-time highs, no banking union was set up, and political environments in the peripheral countries remained caustic.
Paging through economic data wouldnt have yielded an answer the suggested the Euro was due to rebound. History now shows it would
have been a costly decision to remain bearish EURUSD in the second half of 2012.
Fundamental traders really, any trader who uses a longer-term timeframe of analysis cant afford to miss the signals that the market
is turning when it is. That is not to say that a trader needs to time every single turn in the market; thats impossible. Sometimes, the best
trade is the one not taken. Even a trader with a bearish EURUSD bias could have used simple rule system to avoid getting stuck in on the
wrong side of the trade like never shorting a top performing currency on the day.
The StrongWeak application, a timeframe momentum filter, can serve this purpose for the longer-term trader. This is by no means to say
that it will identify a profitable trading opportunity. What it can do for a trader is help easily identify what currencies are performing well
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and what currencies are not. The StrongWeak app, at minimum, is a tool to help foster more intelligent risk management knowing
when not to take a trade is just as important as know when to take a trade.
The StrongWeak App will automatically grade each of the eight currencys strength or weakness over four timeframes: m15, H1, H4, and
D1. It will automatically display this data on a rolling basis (computed on 5-minute bar intervals) so that traders can quickly gauge which
currencies may be most amenable for their goals, as shown below:

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The StrongWeak app also may serve as a tool for traders to look for opportunities. On November 21, 2013, I published an article entitled,
Euro, Pound Rally versus Commodity Bloc
EURAUD Breakout Looming? At the time, I wasnt interested in the EURAUD in either direction it had been range bound for several
months and my personal trading style is to trade breakouts and manage momentum positions.
The StrongWeak app drew my attention to a top performer on the H4 timeframe, the EURAUD. While GBP was the top performer on this
timeframe, the EUR was the second best; and AUD was the second worst performer. Logically, EURAUD would be a top performer. A turn
to the chart revealed that a sideways channel had formed from August to November, and price was testing topside resistance:
EURAUD H4 Chart: July 31 to Present

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The commentary in the report was as follows:

- A daily close above 1.4510 would suggest a breakout may be imminent; more confidence is gained on a daily close above 1.4560.
Flag extension targets taken on H4 see a break of 1.4560 targeting 1.4586 (61.8% extension), 1.4752 (100% extension), and 1.5020
(161.8% extension, 2013 high).
By no means is this heroic analysis its simply the application of risk management in the proper trading conditions. By looking for a trade
in the direction of one of the strongest performing currencies on the day, a potential opportunity appeared. The path of least resistance
became clear, and over the next three weeks, the market did the heavy lifting:

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EURAUD H4 Chart: August 11 to December 4, 2013

08/17 08/25

Sep

09/09

09/17

09/25 Oct 10/05 10/13

10/21

Nov

11/09 11/17

11/25 Dec
1.51561
1.5000

1.4750
1.47519

9
1

1.45861
1.4500

1.4250

08/11/2013 21:00 09/03 17:00

12/03 13:00

09/18 13:00

10/03 09:00

10/18 05:00

1.4000

11/03 21:00

11/18 17:00

Want to automate your trading or trade baskets of currencies? Try Mirror Trader.
The market evolved from a range over the past three months to a streaking breakout over the next three weeks. The full target of 1.5020
was achieved from the initial 1.4510 breakout level, and the only requirement by the trader was to use proper position sizing to manage
risk.
The prior example is of course a very optimal example. While technical analysis is built on the idea that short-term momentum in markets
exists, trends can change at a moments notice. The EURAUD breakout could easily have been another inflection point in at range
resistance just as it was in late-September and late-October.
For a fundamental-based trader, there would have been no way to know that market conditions had formally changed on November 21.
The only information at the time was that the range had been broken; a pure fundamental trader would have been stuck looking for a
story to explain the breakout.
Written by Christopher Vecchio,Currency Analyst for DailyFX.com

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