Best wishes for a safe and happy holiday season.
Thursday, December 24, 2009
Trading Breakouts
Breakouts happen when price moves beyond support or resistance or violates a trend line. They’re an alert that something has changed—the balance of buyers and sellers has shifted or the trend is resuming or reversing. They limit the potential loss since stops can be placed just inside the breakout range.
Many breakouts fail. As Forex traders, it’s important to confirm the price movement before trading. You want evidence that the breakout is real.
Traders use various methods for confirmation. One is to wait for the close of the candle where the breakout takes place. Some traders wait for two candles to close. This is not fail-proof especially in a short-term chart.
Other traders wait for price to move a certain number of pips beyond the breakout. Using Average True Range (ATR), the average pips the pair moves in a given time period, can help determine that number. If the average is 10 pips in a fifteen-minute period, for example, the trader would enter when price exceeded that amount.
A look at the USDCHF 15-minute chart below shows the shortcoming of both methods. There are five total breakouts. In the first two, waiting for the close of one or two candles wouldn’t have assured a safe trade. Two candles closed above resistance in what looked like a vigorous upward breakout. Later, three candles closed below support. Using number of pips based on ATR would have resulted in the trader entering both trades since ATR was less than the breakout amount. In addition, the high volatility surrounding this pair would likely have resulted in slippage, increasing the loss amount.
Some traders mix time and price—e.g. the second candle that closes beyond the breakout has to close further away than the first one does. The combination increases the reliability. This approach would have kept the trader out of all breakouts except the last one in USDCHF.
Another method is to let price breakout and then return back to the breakout point before trading in the direction of the breakout. While the first four breakouts would have resulted in losses, those losses would have been small since the stop would be immediately inside the zone from which price broke out.
Perhaps most important is to stay aware of total price action and typical price behavior before trading a breakout. For example, breakouts tend to take place after a period of consolidation. What was price doing before the consolidation? In the case of USDCHF, price was trending down. That suggests the need for caution on the first upward breakout. The volatility around the breakout is also suspicious. It suggests a news event might be responsible. Breakouts can happen on news but they’re often reversed. After the large upward spike, the second break downward, within the hour, should have signaled that the pair was reacting rather than behaving normally. Finally, one can verify the breakout on a larger time frame. Breakouts on a 15-minute chart can be checked against the action on the hourly chart.
The five breakouts in USDCHF confirm how tricky breakout trading can be. But by the last breakout, the trader has hints price pressure is upward. The second candle is strongly bullish. It closes further away than the first one did. This breakout is still unfolding as I write this but it looks promising.
Take a look at a breakout that’s more straightforward. In the GBPUSD one-hour chart, the pair was in a strong uptrend before consolidating. Price broke out with a strong candle. The second candle retested resistance but its close was solidly above the first candle. The breakout in the direction of the prevailing trend offered reassurance that this breakout was meaningful.
Breakouts can be profitable which is why many trading systems are based on them. However traders must confirm the breakout and consider the overall price behavior.
© Dianne Fecteau, 2009.
Many breakouts fail. As Forex traders, it’s important to confirm the price movement before trading. You want evidence that the breakout is real.
Traders use various methods for confirmation. One is to wait for the close of the candle where the breakout takes place. Some traders wait for two candles to close. This is not fail-proof especially in a short-term chart.
Other traders wait for price to move a certain number of pips beyond the breakout. Using Average True Range (ATR), the average pips the pair moves in a given time period, can help determine that number. If the average is 10 pips in a fifteen-minute period, for example, the trader would enter when price exceeded that amount.
A look at the USDCHF 15-minute chart below shows the shortcoming of both methods. There are five total breakouts. In the first two, waiting for the close of one or two candles wouldn’t have assured a safe trade. Two candles closed above resistance in what looked like a vigorous upward breakout. Later, three candles closed below support. Using number of pips based on ATR would have resulted in the trader entering both trades since ATR was less than the breakout amount. In addition, the high volatility surrounding this pair would likely have resulted in slippage, increasing the loss amount.
Some traders mix time and price—e.g. the second candle that closes beyond the breakout has to close further away than the first one does. The combination increases the reliability. This approach would have kept the trader out of all breakouts except the last one in USDCHF.
Another method is to let price breakout and then return back to the breakout point before trading in the direction of the breakout. While the first four breakouts would have resulted in losses, those losses would have been small since the stop would be immediately inside the zone from which price broke out.
Perhaps most important is to stay aware of total price action and typical price behavior before trading a breakout. For example, breakouts tend to take place after a period of consolidation. What was price doing before the consolidation? In the case of USDCHF, price was trending down. That suggests the need for caution on the first upward breakout. The volatility around the breakout is also suspicious. It suggests a news event might be responsible. Breakouts can happen on news but they’re often reversed. After the large upward spike, the second break downward, within the hour, should have signaled that the pair was reacting rather than behaving normally. Finally, one can verify the breakout on a larger time frame. Breakouts on a 15-minute chart can be checked against the action on the hourly chart.
The five breakouts in USDCHF confirm how tricky breakout trading can be. But by the last breakout, the trader has hints price pressure is upward. The second candle is strongly bullish. It closes further away than the first one did. This breakout is still unfolding as I write this but it looks promising.
Take a look at a breakout that’s more straightforward. In the GBPUSD one-hour chart, the pair was in a strong uptrend before consolidating. Price broke out with a strong candle. The second candle retested resistance but its close was solidly above the first candle. The breakout in the direction of the prevailing trend offered reassurance that this breakout was meaningful.
Breakouts can be profitable which is why many trading systems are based on them. However traders must confirm the breakout and consider the overall price behavior.
© Dianne Fecteau, 2009.
Wednesday, December 23, 2009
Trading Systems
A trading system is a set of rules, usually based on technical indicators, that defines when a trader enters and exits trades. In addition to increasing profitability and limiting risk, a trading system removes emotion and subjectivity from trading decisions.
All traders should use a trading system. However, no one system works in all types of market conditions. As a result, the Forex trader needs two or three systems at their disposal and must know when to switch among them.
The main types of trading systems are trend-following, counter-trend or range, breakout or counter-breakout, and pattern recognition.
Trend following systems are the most common type of system that traders use. They can be very profitable because within a strong trend, moves are often large ones. Trend following systems buy high and sell higher as prices move upwards. One example of a trend following system is a moving average (MA) crossover approach. A trader would buy when a faster MA crosses above a slower MA. In this example on the three-hour Euro chart, you can see three buy points as the 20 EMA (in purple) crosses up above the 50 EMA (in red). You also have one sell point where the 20 EMA crossed below the 50 EMA. All these trades would have been profitable had you trailed your stop.
While trend following systems work well within a strong trend, they cause whipsaws when the market is moving sideways. Notice the circled area on the chart in November. Following the system would have resulted in four unprofitable trades.
In a market moving sideways, the trader needs to switch to a range or counter-trend system. Ranges can be horizontal, ascending, or descending, but they all have a definable top and bottom. There’s greater risk in this approach because you’re trying to pick tops and bottoms—in other words, you’re trying to buy-low and sell-high. Counter-trend systems often involve the use of such indicators as RSI, MACD, and the stochastic, looking for overbought and oversold conditions. They can also use divergences between price and indicators, or crossovers in Bollinger Bands.
Look at the Euro chart below. I’ve added Bollinger Bands to the same three-hour chart during the sideways period in November. Here you’d sell when price touched the upper band and buy when it touched the lower one. It looks simple enough. Remember, though, that counter trend trading carries significantly more risk. As a result, you should always look for other, confirming evidence. (Frankly, even with trend following systems I look for additional evidence for entries.) In this case, note the difference in candle behavior on the last trade that failed. Instead of the upper shadows that the prior candles displayed when they touched the top of the bands, you see stronger candles forming with no upper shadows.
Breakout systems trade breakouts from ranges. The philosophy is that prices don’t stay in a range forever—eventually they break out of them. Counter-breakout systems trade an assumption that many breakouts fail. One example of a breakout system is on the chart above where the last failure for the range trading system was actually a signal for a breakout system. In this case, the breakout was from the Bollinger Bands.
Pattern recognition systems can be the most challenging because there’s the need to recognize the pattern. They include such patterns as inside and outside bars, candlestick patterns, flags, triangles, head and shoulders, and others.
To be useful, trading systems need to have well-defined and simple rules. In addition, the trader must be aware of the market environment and use the appropriate system at the correct time. Determining whether a market is trending or in a sideways range often requires the use of an indicator such as ADX, which I’ll cover in a future article. As always, the trader should look for confirming evidence before entering a trade and should use stop losses to limit risk.
© Dianne Fecteau, 2009.
All traders should use a trading system. However, no one system works in all types of market conditions. As a result, the Forex trader needs two or three systems at their disposal and must know when to switch among them.
The main types of trading systems are trend-following, counter-trend or range, breakout or counter-breakout, and pattern recognition.
Trend following systems are the most common type of system that traders use. They can be very profitable because within a strong trend, moves are often large ones. Trend following systems buy high and sell higher as prices move upwards. One example of a trend following system is a moving average (MA) crossover approach. A trader would buy when a faster MA crosses above a slower MA. In this example on the three-hour Euro chart, you can see three buy points as the 20 EMA (in purple) crosses up above the 50 EMA (in red). You also have one sell point where the 20 EMA crossed below the 50 EMA. All these trades would have been profitable had you trailed your stop.
While trend following systems work well within a strong trend, they cause whipsaws when the market is moving sideways. Notice the circled area on the chart in November. Following the system would have resulted in four unprofitable trades.
In a market moving sideways, the trader needs to switch to a range or counter-trend system. Ranges can be horizontal, ascending, or descending, but they all have a definable top and bottom. There’s greater risk in this approach because you’re trying to pick tops and bottoms—in other words, you’re trying to buy-low and sell-high. Counter-trend systems often involve the use of such indicators as RSI, MACD, and the stochastic, looking for overbought and oversold conditions. They can also use divergences between price and indicators, or crossovers in Bollinger Bands.
Look at the Euro chart below. I’ve added Bollinger Bands to the same three-hour chart during the sideways period in November. Here you’d sell when price touched the upper band and buy when it touched the lower one. It looks simple enough. Remember, though, that counter trend trading carries significantly more risk. As a result, you should always look for other, confirming evidence. (Frankly, even with trend following systems I look for additional evidence for entries.) In this case, note the difference in candle behavior on the last trade that failed. Instead of the upper shadows that the prior candles displayed when they touched the top of the bands, you see stronger candles forming with no upper shadows.
Breakout systems trade breakouts from ranges. The philosophy is that prices don’t stay in a range forever—eventually they break out of them. Counter-breakout systems trade an assumption that many breakouts fail. One example of a breakout system is on the chart above where the last failure for the range trading system was actually a signal for a breakout system. In this case, the breakout was from the Bollinger Bands.
Pattern recognition systems can be the most challenging because there’s the need to recognize the pattern. They include such patterns as inside and outside bars, candlestick patterns, flags, triangles, head and shoulders, and others.
To be useful, trading systems need to have well-defined and simple rules. In addition, the trader must be aware of the market environment and use the appropriate system at the correct time. Determining whether a market is trending or in a sideways range often requires the use of an indicator such as ADX, which I’ll cover in a future article. As always, the trader should look for confirming evidence before entering a trade and should use stop losses to limit risk.
© Dianne Fecteau, 2009.
Tuesday, December 22, 2009
No trading today
I won't be trading for the rest of the week. I still have short trades in the Euro and EURJPY that are profitable as well as a long trade in the USDCAD that's profitable.
For the blog over the next few days, I'm scheduling the automated posting of some of my articles written for other sites. These will touch on trading systems, indicators, and trader psychology.
I caution everyone about erratic moves in the currency markets over the next several days because of thin liquidity. It's time to take a step back, relax, and get ready for next year.
For the blog over the next few days, I'm scheduling the automated posting of some of my articles written for other sites. These will touch on trading systems, indicators, and trader psychology.
I caution everyone about erratic moves in the currency markets over the next several days because of thin liquidity. It's time to take a step back, relax, and get ready for next year.
Monday, December 21, 2009
USDCAD—still fighting resistance
This pair was the first to hint at coming dollar strength and I’ve blogged about many profitable, long trades since mid-October. However, it is languishing at best, unable to break through a downward resistance line from August. It touched this line again last week at 1.0747. This was the 5th touch. I wouldn’t expect much from it for the rest of the month unless thin liquidity results in some exaggerated moves. I’m still long from 1.0413 but my second long from 1.0527 profit stopped out at +20 pips on the recent dip.
Here’s the daily chart:
© Dianne Fecteau, 2009. No part of this material may be reproduced in any form, or referred to in any other publication, without the express written permission of the author.
My purpose in writing this blog is to show you how one trader, me, makes trading decisions and survives while trading Forex. One of the biggest problems I had when I first started trading was trying to apply the “rules” to actual trades. Another was the psychology—limiting losses and letting profits run. If you study my blog you’ll see how I deal with both those issues. So my writings are not trade recommendations but rather educational in purpose. You have to decide on your own approach to trading. Remember that trading is risky.
Here’s the daily chart:
© Dianne Fecteau, 2009. No part of this material may be reproduced in any form, or referred to in any other publication, without the express written permission of the author.
My purpose in writing this blog is to show you how one trader, me, makes trading decisions and survives while trading Forex. One of the biggest problems I had when I first started trading was trying to apply the “rules” to actual trades. Another was the psychology—limiting losses and letting profits run. If you study my blog you’ll see how I deal with both those issues. So my writings are not trade recommendations but rather educational in purpose. You have to decide on your own approach to trading. Remember that trading is risky.
EURUSD—no significant bounce yet
EURUSD hasn’t yet managed to bounce from the 1.4261 low it reached on the 18th. I’m still short from 1.4585. The second short I took last Friday from 1.4385, profit stopped out at 1.4356 for +29 pips.
Action seems confined, in general, to a downward sloping rectangle. If I was trading this week (and I’m not), I could have shorted again at 1.4373. Candle behavior supported the idea of shorting with the upper shadows and the almost evening star pattern. Evening stars are three-candlestick patterns that take place after an uptrend. First, there’s a bullish candle. A star follows. The third candle is a bearish candle that closes deeply within the first candle’s body. In this case, it closed below the first candle’s body which is why I wrote, “almost.” The pattern is bearish.
Note the morning star to the left when price touched the bottom of the rectangle. It’s the reverse of the evening star. It occurs after a downtrend with the first candle a long, bearish one, the second candle a star, and the third candle closing deep within the first candle’s body. If the price approaches the bottom of the channel again, a bullish candle or pattern would justify taking a long position but use very tight stops. The pair also seems to be trying to find support at 1.4280.
Be careful trading this week. In fact, try to take the week off. Here’s the one-hour chart:
© Dianne Fecteau, 2009. No part of this material may be reproduced in any form, or referred to in any other publication, without the express written permission of the author.
My purpose in writing this blog is to show you how one trader, me, makes trading decisions and survives while trading Forex. One of the biggest problems I had when I first started trading was trying to apply the “rules” to actual trades. Another was the psychology—limiting losses and letting profits run. If you study my blog you’ll see how I deal with both those issues. So my writings are not trade recommendations but rather educational in purpose. You have to decide on your own approach to trading. Remember that trading is risky.
Action seems confined, in general, to a downward sloping rectangle. If I was trading this week (and I’m not), I could have shorted again at 1.4373. Candle behavior supported the idea of shorting with the upper shadows and the almost evening star pattern. Evening stars are three-candlestick patterns that take place after an uptrend. First, there’s a bullish candle. A star follows. The third candle is a bearish candle that closes deeply within the first candle’s body. In this case, it closed below the first candle’s body which is why I wrote, “almost.” The pattern is bearish.
Note the morning star to the left when price touched the bottom of the rectangle. It’s the reverse of the evening star. It occurs after a downtrend with the first candle a long, bearish one, the second candle a star, and the third candle closing deep within the first candle’s body. If the price approaches the bottom of the channel again, a bullish candle or pattern would justify taking a long position but use very tight stops. The pair also seems to be trying to find support at 1.4280.
Be careful trading this week. In fact, try to take the week off. Here’s the one-hour chart:
© Dianne Fecteau, 2009. No part of this material may be reproduced in any form, or referred to in any other publication, without the express written permission of the author.
My purpose in writing this blog is to show you how one trader, me, makes trading decisions and survives while trading Forex. One of the biggest problems I had when I first started trading was trying to apply the “rules” to actual trades. Another was the psychology—limiting losses and letting profits run. If you study my blog you’ll see how I deal with both those issues. So my writings are not trade recommendations but rather educational in purpose. You have to decide on your own approach to trading. Remember that trading is risky.
Choppy Price Action this Week
Expect price action to be choppy this week. Thin liquidity means moves will be exaggerated and may not be particularly meaningful.
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