This trading technique has been developed in a unique way. I firstly identified what kind of market movement I wanted to trade: - a Long candle (A quick move in the market). So, rather than looking for a particular technique I took a reverse engineering approach.
I firstly looked at the trading charts and identified all the 60 pip 1 hour candles that occurred over a period of 6 months for 3 currencies (GBPUSD, EURUSD and USDJPY). When you have a number of students to help, this exercise becomes a little easier. We then gathered key information about each candle such as the exact time of the day they occurred, noted any economic announcements that may have occurred and exact size and strength of the trend etc. This supplied fantastic information regarding the time and events that made these candles occur. This alone was worth the effort.
We then took it a little further. We looked at all the trading signals that occurred just before the Long candle trend. We looked at the support and resistance levels that were in place to determine why the candle started where it did and stopped where it did. More importantly we looked at the trading triggers (as opposed to signals) that would activate a trade into the candle trend. Although predictable to some degree, the information was incredible.
We found that 1 leading indicator gave a trading trigger in 90% of the time! Furthermore there was only a handful of trading signals supporting these moves.
Trading signals give evidence of a likely transaction and supports the likelihood of the transaction being successful. A momentum divergence is an example of a very strong trading signal.
The trigger is the event that will activate the transaction. It could be something like the price reaching a certain price level or an event like a trendline violation or bounce.
In most cases you would have a number of trading signals providing overwhelming evidence for you to pull the trigger.
Our findings were:
A simple straight line proved to be the most consistent indicator of a transaction entry point. This straight line can be a non horizontal trendline or a horizontal support and/or resistance line. Straight line signals and triggers can be found on both the price chart and on the indicator chart.
Momentum indicator signals – wave counts, divergences, trendline violations
Non Horizontal support and resistance – trendlines, channels, dominant angle lines
Horizontal support and resistance – historic support and resistance, Fibonancci levels
Candle formations – Continuation and reversal formations.
Price pattern formations - Continuation and reversal formations
Time of day factors – Major Market Volumes, Announcements
So rather than complicating the process we found a simplified approach using 6 conventional trading signals and found ONE simplified trading trigger that applied to 90% of long candle trades.
Another way we stumbled on the power of a trendline was when doing strategy or indicator optimisation. The best way of improving the results of an indicator or trading strategy is by introducing a filter to reduce negative transactions.
A strategy or transaction filter is an additional condition you would place on the decision making process before a transaction is entered into.
An example: One of the most basic trading strategies is the moving average crossover strategy which has the following simple rules. When the fast moving average crosses over the slow moving average from above and the price closes below the slow moving average, enter a SELL.
Enter into a BUY transaction when the fast moving average crosses over the slow moving average from below and the price closes above the slow moving average.
This strategy can be optimised to find the best settings and the most profitable time span historically by doing programmed back testing. After the optimisation the next step we would add filters to try to avoid the unprofitable trades.
Sometimes a simple filter such as: - “Ignore signals that occur between 21:00 and 5:00 GMT”. Trading during quite markets generally results in false signals.
In General we have found the filter: - “Only enter into signals that occur at the same time or just after a trendline violation” reduces negative transaction considerably for all breakout indicator or trading systems tested.
Other general filters include:
Ignore trading signals which occur at low volume times outside of the high volume active major market times (this is one of the main principles of this course)
Do not use trending indicators (Moving average etc) in sideways markets.
Do not use momentum type (MACD / RSI) indicators in trending markets.
The importance of the use of trendlines violations (crossovers) and bounces was again confirmed in 2 totally separate ways.
A Trendline is a line that connects the major turning points on a chart. By connecting the turning points you are effectively creating a barrier between the area where the Bulls are in charge and the area where the Bears are in charge. By drawing trendlines you are projecting future bounce and breakout points (Bull and Bear battles) where the price will move quite quickly. Long Candles occur when the price bounces or breaks through the trendlines.
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Trendlines provide great opportunities to catch long candles when they are violated or cause price to bounce.
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Click here for a typical trendline violation trade: Trendline violation GBPJPY +125Pips
Please go to the Prof FX blog for a number of trendline violation trades. Enter “trendline” in the search facility.
Most traders would like their trades to be quick, definite moves that go straight to their target giving them the least amount of anxiety. This kind of move is represented as a long candle on the charts – hence the name of this course. Quick moves are also sometimes represented by a spike candle which has a long tail and a small body.
Long Candles: There are basically 3 types of long candles.
Long candles that are made when the price breaks through (violates) strong support or resistance – I call these breakout trades
Long candles that are created when support or resistance is so strong that the price bounces back from where it came from. Many times this move is so fast that a long candle does not form. What you see is a spike shaped candle. I regard these as long candles too and I call these bounce trades.
Then there are those long candles that are part of a fast moving trend. These are more difficult to enter as you don’t have many supporting signals except the trend itself.
To get a better understanding of long candles lets looks at when they likely to occur:
1. At market openings
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Although the Forex market is a 24 hour market the participants are all human beings who sleep and go to the office. The markets are quieter when the trading hours of major markets are not active. Certain currencies react differently to market openings.
The GBPUSD tend to be very volatile at the opening of the European market and there is a particular trade I call the Big Ben Trade that takes advantage of this volatility. Some successful alert services take advantage of this volatility and would merely straddle the European market opening every day.
The USDCAD is also very volatile at the opening of the US market as that is the main market in which the CAD (the Looney) is traded.
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Market openings can produce very interesting results. The US market opening starting at 8:30 EST can be very volatile as it is the preferred time for economic data releases in the US.
Choose your 3 favourite currencies. Use the GBPUSD, EURUSD and JPYUSD if you don’t have any favourites.
Use the 15 minute charts.
Mark the last 10 European market openings (6:00 GMT) and US market openings (13:30 GMT/8:30 EST) each currency chart.
Now study the price behaviour for each currency during the first 3 hours of these 2 market openings with the object of trying to find an element of consistent behaviour that one can trade.
Do you notice consistent increased volumes?
Do you notice consistent whipsaws?
Do you notice consistent breakouts?
Do fast (period settings of 4 to 5), 5 to 15 minute, momentum indicators give a clue of possible market direction?
Increased volumes could add to the strength of market moves, pushing the price into a short term (1 to 3 hour) trend.
Whipsaws indicate a washout activity in the market where the market gets rid of buy and sell orders before choosing a direction. This could indicate that one should stay out of the market for the first hour or so.
Consistent breakouts show that one could possibly use a straddle trading approach to market openings.
Momentum indicators can be used as direction indicator trading signals supporting trendline violation triggers
The exercise below will help you develop strategies for trading the market openings. Many Forex Alert services use these techniques to generate consistent trading results. Why pay an alert service if you can do it yourself?
Your findings in the above exercise could point to the use of the following strategies.
If you find the market is making more breakouts than any other price movement trade the following strategy for the next 5 days:
Draw 2 sets of trendlines over the most recent high and lows.
Place a buy order 8 pips above the upper trendline and 5 pips below the lower trendline.
Use the lower entry as a stop for the buy and the upper entry level as a stop for the sell.
Target 60 pips with a 30 pip (pip by pip) following stop.
Set and forget at the 6:00 GMT and 13:30 GMT every day for a week.
An alternative to using trendlines is:
Place a buy 23 pips above the current price and 20 below the current price at 6:00 GMT and 13:00 GMT.
2. After announcements
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Major economic announcements and political and economic speeches supply new information to the market. When the information differs from what is expected it could result in tremendous moves in the market.
The most common way to trade these announcements is to straddle the trading range before the announcement and let the volatility of the move activate the transaction.
Looks easy, doesn’t it? You would have to exit by watching the price action, when you have made enough, using a target or a following stop.
There are however a few traps to this trade. You have to enter the trade in the last minute before the announcement. Some Brokers don’t like this and increase the spreads before an announcement. Some broker systems can’t handle the volatility of the move and the dealing system may hang or freeze which restricts your management of the transaction.
In reality the price often gets lost and even the broker can’t locate it. The other dangers are whipsaws where the price goes the wrong way before breaking in the intended direction. Occasionally the price does very little when the announcement outcome is exactly what was expected.
These trades are regarded as high risk trades but can be fun as your risk return ratio can be very good. Sometimes you can risk 15 pips and make 90. One of the reasons why some traders continue trading this trade as they only need 1 in 6 to work to break even.
When you are in an active deal just prior to an announcement I would suggest that you close the deal or if you trust the brokers trading system move your stop very close to the existing price. This will prevent your transaction from creating big losses. You could at the same time increase your target before the announcement if you are fortunate enough to be going in the right direction.
3. After the price breaks through strong support or resistance.
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In this example the bulls have been defending a specific non horizontal support area a number of times. The strength it takes for the BEARS to break through the strong support invariably results in a long candle.
This trade is normally activated by placing a sell order just below the support line. When the price violates or breaks through the support line it would activate the order which would act as the trigger for this transaction. Trading signals include the momentum divergence, the momentum trendline violation.
4. After the price bounces off strong support and resistance
The price will normally bounce back from strong support and resistance. The example below shows 4 support lines occurring at the same place creating very strong support. A strong bearish candle is quickly bounced off this combined support creating a long upward candle. The support is created by:-
A channel lower support line (this line could also be a trendline in its own right)
A horizontal support and resistance line
A non horizontal support and resistance line
And a 61.8% Fibonacci retracement line
These support and resistance concepts will be explained later in the course – click on the blue words to link to the more detailed discussions.
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5. During strong trends
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During strong trends the price is moving with considerable speed and long candles tend to develop at all stages of a trend. Even during trending periods, trendline violations will still get you into most trends and help you catch the long candle.
We will learn about some of the signals later in the course but the head and shoulder formation at the end of a trend is a great reversal formation. The violation of the Head and Shoulders neckline would have helped us activate a sell transaction.
The violation of the bull trendline would have helped us catch a second long candle. The violation of a “with the trend” non horizontal support and resistance line would have helped us catch another long candle.
6. During strong market corrections
Sometimes when a trend develops (especially when the trading volumes are low) and the price reaches a level where major players feel uncomfortable they would enter the market with large orders. These orders would be large enough to not only stop the direction of the current trend but to reverse the direction completely. A few years ago the Japanese Government had a habit of making large market interventions in an effort to control the price levels of the Yen.
These activities are noticeable on daily charts as well as 5 minute charts. The evidence is normally reflected on charts as large candle spikes or railway track formations.
Below are examples of BIG bulls protecting the price of the USDJPY from going any lower. The bull order eventually reversed the trend.
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7. Breakouts out of market consolidations
Market consolidations occur when all the participants agree on the current price levels. These participants are the bulls, bears, long term traders, short term traders and scalpers. These times of consolidation can be the start of huge trends as the smallest amount of new information can start a big move (Long candle with volatility).
The chart below shows how multiple moving averages using the Fibonacci numbers to 233 helped me visualise the market consolidation that led to an over 1000 pip move on the daily chart of the EUR. The moving averages moved into a funnel which was easy to straddle. A volatility break out with lots of long candles was inevitable.
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Times when not to trade
Don’t trade in Low volatility
Long candles require trading volumes and participation by the Bull and Bears. That is why it is a good idea not to trade during quite times like Public Holidays - Xmas / New Year / Easter / Thanks giving / Independence Day etc. Although the market does have some movement some brokers increase their spreads to discourage trading over these times.
Link to a public holiday trade
Don’t trade in High and uncertain volatility
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Sometimes political speeches and economic announcement can create considerable uncertainty or over reactions in the market. This would be a case of too much volatility and generally it is better not to trade. Take a break.
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