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Forex Currency Trading Strategies
Forex Currency Trading Strategies
The below section forms part 4 of the Defensive Trading course in How to Trade and Invest in Forex. We will begin by looking at the various forms of orders and then delve into the specific trading strategies and setups available for you to use. We close this course with a discussion regarding when you will be able to use your new knowledge to become a professional (tull-time) trader.
The first point we discuss in this part 4 of our course in How to Trade Forex, Forex Currency Trading Strategies, is the use of orders.
When becoming more familiar with forex trading, and trading more generally, you will start to notice something important. Quite often you will notice that once you have formed your opinion on a particular asset from a Fundamental Analysis perspective, and then competed your Technical Analysis on this asset something happens… Often the price is not yet at the level that believe it should be at in order for you to enter your trade.
For example, if you have noticed what you think is a double top chart pattern in an asset, which is a reversal pattern, however, the price is not yet at the price point to touch on the top. So what do you do? Sit and watch the chart tick up and down incessantly 24 hours a day? Well, thankfully no there is a solution for this problem. It is known as orders.
Orders allow us to input into the platform’s orders system exactly what level you would like to open your trade at and under what circumstances. Let’s take a look at these options below.
Entry orders are an incredibly useful tool that all traders need to become comfortable with using regularly.
Market orders are manual execution of the order on your software by entering all the specific trade information then selecting Sell or Buy as required. Can result in slippage which occurs when the liquidity on an asset isn’t sufficient to fill your order at the requested price, so it is filled at the soonest price with liquidity.
Are future orders which will be automatically filled once the price reaches the set entry point. There are six varieties of Pending Order:
1. Buy Limit
2. Sell Limit
3. Buy Stop
4. Sell Stop
5. Buy Stop Limit
6. Sell Stop Limit
A Limit Order is set to buy or sell an asset at a set price. Once the asset reaches the set price the order will be filled.
1. Buy Limit Order: A Buy Limit Order is an instruction to buy at a set price or lower.
2. Sell Limit Order: A Sell Limit Order instruction to sell at a set price or higher.
3. Stop Orders: Sell Stop Order, or, Stop Buy Order, is executed AFTER the specified price has been reached. The Buy Stop is placed above the market, and the Sell Stop is placed below the current market.
Stop Loss Order
Set to protect the trader’s capital by limiting the risk exposure on any given trade.
This is another kind of Stop Loss, however, in this instance, it moves in relation to the price fluctuations. This means that the stop chases the price, so that, once you are in your trade, the stop sill always stay a set amount of pips away. This means that no matter what happens, you will never be more exposed than you had initially calculated to be, and at the same time, you can protect your profits once the stop moves beyond your entry point.
One Cancels the Other
OCO is a combination of two pending orders which are set up to account for either outcome of a trading situation. In the event that one of the orders is filled, the other is deleted, or cancelled, as it is no longer needed given the movement of the asset.
Support and Resistance – Support and Resistance analysis can be used on its own or as part of a strategy combining other patterns and/or indicators. Support and Resistance will also be important when we go into Fibonacci Retracements and Pivot Points.
It can be used to assess and validate the price points when looking at possible entry points for trades.
Every trader will have slightly different ways of identifying and implementing Support and Resistance points or zones.
Support and Resistance points or zones are defined as being Major, Less-Major and Minor.
Entry points and Exit points relate to risk management. Poor Risk management is the reason why most traders fail so if you can master details on this point in Chapter 2, then you are already in a select group of traders who are always in control of the two possible outcomes when Forex trading which are will it go up or down.
Support and Resistance are recent and historical points of interest in the behaviour of a forex quote.
Key Support and Resistance levels are also known as psychological levels to reliably anticipate price points as which they make strategic decisions about entry and exit points. These actually become a self-fulfilling in many ways because key levels cause additional buying/ selling pressure on an asset as it reaches a certain price point which, ultimately, will become so strong that it overpowers the current directional move of the asset and causes a reversal of the trend.
Multiple timeframe analysis – when looking for major levels of Support and Resistance is best done using Multiple Timeframe Analysis. This requires an asset being viewed and studied across multiple timeframes monthly, weekly and daily down to 1 hour or less depending on which time frame you are trading.
How to Trade?
1. The Bounce: When an asset bounces off the support or resistance point.
2. The Breakout: When the price breaks through the support or resistance.
Fundamental analysis focuses on the underlying reasons why an asset is moving as it is in the market in order to attempt to anticipate the future likely moves. It differs from Technical Analysis in that technical traders do not care about the reasons why an asset is moving in a certain way, but fundamental traders do.
Sentiment is based on the cumulative on balance attitude of traders towards a financial market, generally, or in relation to a particular security. Being able to analyse how many long vs shot positions are currently open on an asset provides great insight into what the overall view of the market is by all contributors. Of course, no matter what the asset, there will always be traders who are taking opposing positions, however, when one dominates the other then you will see a move in that direction.
As initially introduced in the Mechanics of Forex chapter, a carry trade is possible due to the interest rate differential between the two economies of the pair that you are interested in trading.
This strategy works when a trader borrows a currency with a low interest rate and buys with it a currency with a high interest rate economy. It is a very logical process when you stop and think about it. You borrow money at a low interest rate, then invest that money in a high interest investment, the difference between the two it then profit for the trader.
This strategy is very popular because it allows a trader to find profits in low-volatility areas and takes advantage of relatively stable markets. Especially when you consider that interest rates are reviewed quarterly, there is a lot of warning of a change in circumstances.
This logic can then be taken further, whereby a trader will buy a currency whose interest rate is expected to go up, and to sell a currency whose interest rate is expected to go down. As we learned in Advanced Analysis of Forex, this will work in the trader’s favour, not just due to the interest rate differential, but also because the price of the underlying currency will also increase accordingly due to the increased demand for that currency. This is a very nice trading opportunity.
Assets in the financial are said to have a correlation when they have a tendency to move in relation to each other.
The correlation can either be positive or negative.
Two assets are said to be positively correlated when they move in a direct way to one another (i.e., they both go up at the same time).
The assets are said to be negatively correlates when they move indirectly to one another, (i.e., one goes up and one goes down during the same period of time).
Common correlations tend to be most predominant between currencies and commodities and equity indexes such as:
1. Canada (CAD) and the price of Crude Oil: Canada is a major exporter of oil and is therefore the two have a positive correlation.
2. Japan and Oil: Japan, on the other hand, is a large exporter of Oil, and therefore had a negative correlation to the price of Oil.
3. Therefore, the logical question would be to trade CAD/JPY, however, it is important to note that the CAD/JPY can often have a wide spread and depending on the direction of the trade, may incur high swap fees as Japan historically has very low interest rates.
In order to properly visualise the correlations on the charts, we have a Meta Trader indicator which will overlay one chart on top of another so that you can see the convergence or divergence of the prices.
Note that as economic conditions change with time, so too will the correlations that may have been apparent
Some further correlations include:
1. Positive: USD and Gold, Gold and Silver, AUD/USD and Gold, NZD/USD and Gold, USD/CHF and Gold
2. Negative: EUR/USD and USD/CHF
As the trading conditions are continually changing, there is a Meta Trader indicator to overlay several charts on top of one another in the same chart window.
Hedging is generally understood to be a way that a trader will protect their capital by taking an offsetting position, which, in the event that that the climate changes without warning.
In Forex trading, this strategy best works when the two assets purchased are negatively correlated. See correlated assets above.
One of the key differences in this trading strategy is that is it not designed t be used to make a profit per se but to defend one’s position against losses and to mitigate risk.
As we discussed at length in Part 3, the importance of News releases cannot be underestimated. It is the incremental release of economic data which is largely responsible for the supply and demand, and therefore price, of the asset.
In order to be able to take advantage of these releases of information you need to know when they are coming out. This is done through the use of an Economic Calendar, such as the one available on Markets.com.
A word of warning, however, in this area: As a beginner trader, please exercise caution of trading the news. The movements of the assets can be exceptionally unpredictable. Often the asset will trade sharply in a direction which is absolutely opposite to what logic would predict. This is a sure-fire way to lose money in a hard and fast game in which you are a small player.
If you are interested in trading the News, perhaps watch a few rounds of the releases that interest you, such as NFP etc. Once you feel that you have a sufficiently well established understanding of how many pips and in what timeframes the asset moves then you may be able to enter the market on the subsequent occasion.
If you are insistent on trading the news, the best course of action would be to wait until the asset commences it’s established directional move (as opposed to whipsawing about uncontrollably). In order to see this, you will need to have the time frames of the charts of the associated assets on quite low timeframes, 5 Minutes, for example. Once this has taken place, you will be able to identify when the asset retraces. This will be a safer place to enter the market, instead of trying catch a falling knife.
Support and Resistance
A Pivot Point is essentially a turning point of an asset. It is calculated by taking the average of the high low and closing price of an asset (see formula). The aim of this strategy it to buy at the lowest point and sell at the highest. It is a way of attempting to predict what the future potential Support and Resistance areas will be.
Using Pivot Points to calculate levels is most useful when used in a short-term trading strategy and can be used as trade set-up for a bounce or break trade.
As Pivot Points are essentially just another way of identifying potential Support and Resistance levels, they can be traded in the exact same way.
The term Pivot actually indicates that it will be a turning point of an asset’s price (Bounce), however, as with other Support and Resistance levels, they can be broken (Break).
When using Pivot Points, the calculations performed will generate 3 levels of Support and 3 levels of Resistance.
Pivot Points are calculated as follows:
1. Pivot point (PP) = (High + Low + Close) / 3
2. First resistance (R1) = (2 x PP) – Low
3. First support (S1) = (2 x PP) – High
4. Second resistance (R2) = PP + (High – Low)
5. Second support (S2) = PP – (High – Low)
6. Third resistance (R3) = High + 2(PP – Low)
7. Third support (S3) = Low – 2(High – PP)
How to trade?
|Trade||Conditions||Entry||Target / Stop|
|Bounce||Let’s say that the price is approaching Support (S1) and is about to test this level. If you believe that it will bounce off this level and not break it then do the following:||Entry for this trade will be just above S1. As with the previous Bounce trade, the conservative trader will wait for the asset to test the S1 level, bounce off it and begin to retrace. Once this confirmation has been seen then the trader is OK to open their position.||In this case, the first Target to set a Take Profit level will be the Pivot Point level itself, however, as a secondary option for a more aggressive trader, the R1 level could also be used as a profit target level. Take Profit can then be set at the level for a more aggressive trader, or slightly before the level for more conservative trader.|
|Break||Let’s say that the price is approaching Support 1 (S1) and, in this instance, you believe that the asset will continue to move below that level, thus breaking Support.||Entry for this trade will be just below S1, or on the retouch of a retracement to S1 and where the asset now finds resistance there.||The target will be S2 or S3 depending on the move of the asset.|
First discovered by Leonardo Fibonacci, an Italian mathematician, the Fibonacci Ratio is a series of numbers that begins with the number 1 and continues on indefinitely. It is calculated by adding a number with its subsequent create a third and thus continues.
On its own this information doesn’t seem particularly ground-breaking, until you realise that the various calculations that can be undertaken regarding the relationships between the numbers fractions that are repeated enumerable amount of times in the natural world.
From things as varied as the spiral of a shell to the skin of a pineapple all the natural formation of the seeds of a sunflower all adhere to the Fibonacci ratio.
Further than this the ratios have been arranged to create what’s known as “golden mean”, Which is used for out the material world, particularly in design art and architecture. In addition to being used to analyse the movements of financial assets.
This series of numbers is as follows: 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144…
Excluding the first few numbers in the sequence when you divide any number in the sequence to its subsequent number, you consistently get an answer of 0.618. Similarly calculate the ratio between alternative numbers you consistently get an answer of 0.382.
Regarding the financial markets specifically, the Fibonacci ratios are used in two particular forms of calculation the Fibonacci retracement and the Fibonacci extension.
The first, and most commonly understood is the Fibonacci retracement. This is a short-term price ‘correction’ during a trend of an asset, either upwards, or downwards. It is also known as a ‘pull-back’. It is important to note, this is not a ‘reversal’ strategy, it is a continuation strategy.
The second is the extension which depicts the continuation level of a much shorter move than in the retracement. It is used to gain some parameters of the likely targets of the continued move (either upwards or downwards) once a correction has taken place and the price has resumed its initial trend.
Fibonacci Retracements Levels
Fibonacci retracement levels are 0.236, 0.382, 0.500, 0.618, 0.746.
Fibonacci Extension Levels
0, 0382, 0.618, 1.000, 1.382, 1.618.
Luckily you don’t really need to know how any of these numbers are calculated because the software will do that for you.
How to Trade?
Fibonacci retracement levels are used by traders to identify potential support and resistance levels. As with many other technical indicators, because they are so widely used by so many traders, they seem to become self-fulfilling prophecies.
Similarly, Pension levels are used as profit taking levels Who is widespread use also cause them to be self-fulfilling prophecies.
Installing the Fibonacci indicator on a particular chart is quite simple however it is dependent on get raider being able to correctly identify swing high swing low points in the price as seen below.
Generally speaking, the Fibonacci indicators tend to work most effectively when the market is trending.
|Trade||Conditions||Entry||Target / Stop|
|Bounce||The market is trending upwards.||Buy on a retracement that hits a Fibonacci support level. Bounces off it, and continues in the direction of the dominant, overall trend.||Looking for Fibonacci extension levels further along the dominant trend direction than the 0 point of the Fibonacci Retracement level. Note: If the retracement passes the preceding swing high, then it is safe to infer that a trend reversal has taken place and to change the trading strategy.|
|The market is trending downwards.||Sell on retracement at a Fibonacci resistance level. As the resistance holds, and the asset bounces off that level, resuming the direction of the dominant trend.||Looking for Fibonacci extension levels further along the dominant trend direction than the 0 point of the Fibonacci Retracement level. Note: If the retracement passes the preceding swing low, then it is safe to infer that a trend reversal has taken place and to change the trading strategy.|
Note: If the retracement passes the preceding swing low, then it is safe to infer that a trend reversal has taken place and to change the trading strategy.
Fibonacci levels are incredibly useful and had universal appeal, however, they are even more reliable when they are used in conjunction with other forms if Technical Analysis such as already established strong historical Support and Resistance levels, Trendlines, Candlestick and Chart Patterns.
Dynamic Support and Resistance
Dynamic Support and resistance lines can be used in the same way as traditional Support and Resistance lines are, however, as they are generated by a technical indicator, they are constantly changing in response to the assets price.
The indicators that can be used to create dynamic Support and Resistance lines are:
Moving Averages (SMAs, EMAs)
Entering a combination of Moving Averages will offer a first and second level of support and/or resistance. This can be done by entering either Moving Average at a higher and lower period, such as 10 period and 20 period.
Due to the behaviour of the Bollinger bands ranging from Loud to quiet, so does their relationship with the underlying asset. When the asset tends towards trading in the central area between the bands, when there is high volatility (loud), then the price tends to ‘bounce’ off the band as a dynamic support or resistance level.
Ichimoku Kinyo Hyo
This indicator can be used as dynamic support and resistance lines. If the price is above the Senkou Span, then it serves as a first and second dynamic support level. If the price is below the Senkou Span, then it can serve as a dynamic first and second resistance level.
Breakouts are when the price breaks a support or resistance level, traditional or dynamic. They often occur after an asset has made a significant price movement, followed by a period of consolidation. From this period of consolidation comes a ‘break-out’ of the range the asset was in. They can come in two main forms:
This takes place when the asset continues in the original direction of the significant price movement prior to the consolidation.
Conversely, after a period of a significant move in an asset and a subsequent consolidation, an asset will break out in the opposite direction of the initial move.
On the other hand, when there is low volatility (quiet), there is less distance between the bands, the price is said to be squeezed. This is a period of consolidation and is more indicative of a ‘breakout’
Just as would be expected, on occasion the price of the asset spikes or ‘breaks’ above or below the support or resistance level, but the break-out looses power almost immediately. This can be due to a rush of activity based on a news release which doesn’t actually alter the underlying opinion on the asset. These can be seen not just in technical indicators such as SMAs, EMAs, and Bollinger Bands, but also in Chart Pattern Formations.
In order to protect one’s self against this eventuality, the best advice in this case is to wait on entering the trade until the asset has retraced, back to the break-out level. If the break-out is actually a fake-out, then the asset will not continue trading outside the support or resistance level for any significant period of time. Once it returns to the break-level, it will return to the area within the level, however, if the break-out is genuine, the asset will usually bounce off the break level.
Cross Over Trading
When the chart is set up with both the SMAs and EMAs at two different time periods, such as 10 and 20. As the shorter period Moving Average will respond to the price more quickly, when it ‘crosses-over’ the longer period Moving Average, this is a signal of the beginning of a new trend.
as the MACD is made up of a fast and a slow moving average, when a new trend starts, it will be the fast moving that reacts most quickly. When this happens, the fast line will physically ‘cross over’ the slow line.
Ichimoku Kinyo Hyo
In this case, if the Chikou Span crosses the price from the bottom up, then this ‘cross over’ is a buy signal. If it crosses the price from the top down, then this ‘cross over’ is a sell signal.
Divergence trading is the process of spotting the differences in the directions of price and one or more indicators as an indication of the future movement of the asset.
It is used when the RSI, Stochastic, MACD or similar oscillator.
Typically, when the asset is moving in an uptrend, the price and the oscillator will both be making higher highs and higher lows. In this instance there will be no divergence. However, when the asset is set to reverse the trend, you will notice that the oscillator starts to make lower highs than the price. This will on occasion turn into the oscillator commencing a bearish movement while the price is still hanging on to making higher highs, albeit at a much slower pace than during the height of the trend.
The types of divergence can be broken down into two categories; Regular and Hidden, which each have two sub-categories.
Regular Bullish Divergence
it is characterised by the price exhibiting a lower low, the oscillator exhibiting higher lows. This shows underlying buying strength, it can be an indication of a possible change from downtrend to uptrend.
Regular Bearish Divergence
Characterised by the price exhibiting a higher high, the oscillator exhibiting lower highs. This shows underlying buying strength, it can be an indication of a possible change from uptrend to downtrend.
Hidden Bullish Divergence
Characterised by the price exhibiting a higher low, the oscillator exhibiting lower low. This shows underlying buying strength, it can be an indication of an entry point as is it often seen during a retracement during an uptrend and is an opportunity to buy on a ‘dip’.
Hidden Bearish Divergence
Characterised by the price exhibiting a lower high, the oscillator exhibiting a higher high. This shows underlying buying strength, it can be an indication of a possible change from uptrend to downtrend.
Putting it All Together
How you decide to trade is ultimately your own decision. After thoroughly reading through and learning the information within this course, you will be prepared to start to implement trading strategies that best suit your trading style and preferences.
As a general rule, it is not advised to have any more than 3 or 4 technical indicators active on your chart at any one time. Any more, and your eye and mind will be confused by the excess, and often conflicting information they are presenting.
Below are some suggestions of indicators that have been discovered to work well together. Please note that these are in addition to spotting chart and candlestick patterns as well as in addition to support and resistance levels and indicators such as Fibonacci Levels, Pivot Points etc.
1. Bollinger, and stochastic
2. MACD and RSI with moving averages
As the name would suggest, back testing is assessing a strategies effectiveness on long-term or recent historical data (charts) to see if it is something that can be relied upon during the current market conditions. This way you get to see where the correlated buy or sell signals appeared, and the subsequent move of the asset, without actually risking any capital.
As with everything in Forex, there is expensive and unreliable software that you can purchase to perform this task automatically, however, it is preferable, especially as beginner traders, to perform this manually. This way you will be learning all the while. In addition, the best thing about manual backtesting is that it can be done over the weekend while the markets are closed.
Elliott Wave Theory
The Elliott Wave Theory was established by Ralph Nelson Elliott after he studied almost 75 years’ worth of stock market data during the 1920s-1930s.
What he discovered in this period of analysis was that markets tended to adopt repetitive cycles, attributed by Elliot to be the manifestation of the emotions of the various investors in the market due to outside causes. Bear in mind that this was a time of prominence of the psychoanalytic works by figures such as Sigmund Freud and Carl Jung whose theories were founded in the ‘collective consciousness’.
Irrespective of the influences, the theory that was ultimately published by Elliot identified that in terms of the financial markets, established that the movements of the markets could be clearly categorised into various upwards and downwards waves that always appeared in the same repetitive patterns.
Elliott called these swinging motions, waves.
Essentially, this means that if you can correctly identify the section of the pattern, then you would be able to predict where the price of the asset will go.
In order to fully understand and trade with the Elliott Wave Theory, you first need to understand what Fractals are.
A fractal is a curve or geometrical figure, each part of which has the same statistical character as the whole. They are useful in modelling structures (such as snowflakes) in which similar patterns recur at progressively smaller scales, and in describing partly random or chaotic phenomena such as crystal growth and galaxy formation.
Fractals are said to possess a quality known as self-similarity.
The reason this is important to know as a trader is that in actual fact, Elliot Waves can be further broken down into more Elliot Waves, and they also fit into larger Elliot waves.
As you can see in the accompanying image of the Elliot Wave is made up of various phases known as the 5 – 3 wave Pattern.
They are made up of the first 5 group of waves, the impulsive waves; followed by the subsequent 3 waves, known as the corrective waves.
The first phase can be further broken down into motive and corrective movements. Moves 1, 3 and 5 are motive movements; and movements 2 and 4 are corrective movements.
The idea behind this is that each step in this process can be explained by various phases of mass-mentality psychology. Once this is understood, it can be used to the trader’s advantage.
Let’s imagine in a bull market…
This movement is created by a small number of people who, in a short period of time, enter the market having decided that, for some reason or another (fundamental or technical), it is a good time to buy. This increase in demand caused the price of the asset to rise.
In this phase, a portion of the buyers who originally entered the market decide to take profit, considering the price to be overvalued. This drop in demand, causes a drop in price; though not back to the original starting price at the beginning of Wave 1 because the price is still considered by many to be attractive.
This wave is usually the strongest and longest wave. The previous price movements have caught the attention of the masses. This increase in demand causes the price to surge higher, past the highs achieved during Wave 1.
Similarly, to Wave 2, traders again take profit as the stock is again considered overpriced. This correction tends to be less pronounced as there are still a large portion of the trading population who consider the asset a buy and not a sell. This weakness the change of sentiment is reflected in the weakness of the change in price. Most people are still looking for a good entry point and are trading thinking that they are buying at a good price on a pull back.
This is the final Wave of the initial section of the theory. This is the leg that most of the people get into the trade. This is also the point at which the asset is genuinely overpriced and is the beginning of the end of the upward move.
ABC Corrective Waves
After the peak of the 5th Wave, the formation changed direction with the ABC Waves. These generally fall into one of three categories of ABC Corrective waves.
The Zig-Zag formation is a sharp change of direction characterised by the B wave being the shortest wave, in comparison with the A and C waves. It will be moving in the opposite direction to the preceding dominant direction. This formation can actually take place two or three times in a row, however, as with all Elliot Wave formations, the waves can be broken up into smaller wave formations.
This formation is characterised by the three waves having generally equal lengths. With Wave B retracing the move of Wave A, and Wave C undoing that of Wave B.
As with the Triangle formations discussed in the previous chapter, this is made up of either converging or diverging triangles that can be either symmetrical, descending, ascending or expanding. This wave formation is actually made up of 5 waves (A,B,C,D,E)as opposed to the aforementioned 3 (A,B,C).
As you can see from the above image, the Elliott Wave formation is actually made up of smaller Elliot Waves. They can be categorised by various sizes of cycle.
1. Grand Super Cycle
2. Super Cycle
There are also some rules to remember when looking for Elliott Wave Formations in the charts.
1. Rule 1: Wave 3 can never be the shortest wave;
2. Rule 2: Wave 2 can never go beyond the start of Wave 1; and
3. Rule 3: Wave 4 can never cross into the same price area as Wave 1.
Bill Williams was a proponent of self-education in investment who combined ideas from areas as wide reaching as engineering, physics, psychology and integration of mind and body.
His background in these areas, lead to a unique approach to trading the markets whereby he concluded that the reason that people were unsuccessful in investing was because they developed a high level of dependence on various forms of analysis and the rules upon which they were based.
Bill William considered that as the market changed all the time, one could not rely on theories or patterns that has been used in the past.
Instead he created a way of trading that relied on psychology instead of any technical or fundamental analysis.
In order to achieve this, Williams categorised the correct analysis of the markets to fall into five areas:
1. Fractal (phase space): This is the only dimension that generates a signal. All of the other signals generated by the other dimensions should be ignored.
2. The driving force (energy phase)
3. Acceleration (deceleration (power phase))
4. Zone (combination of strength / power phase)
5. Balance Line
Once the trader has opened the position, it can be added to each time that a signal from one of the other dimensions is generated.
Based on this methodology, a 30% market movement give the trader an opportunity to make a profit of 90% to 120%.
How it Works
Acceleration / Deceleration (AC) Oscillator
The AC Oscillator is a technical indicator which displays the acceleration or deceleration of the market driving force at any given moment. It fluctuates around the median (0.00) level, where a positive value indicated a growing (bullish) market, and a negative value signals a shrinking (bearish) market trend development. The main feature of this indicator is that it serves as a forewarning for a potential reversal as prior to the reversal, the indicator changes direction.
This indicator was literally modelled on the observed behaviours of the Alligator. Their activity can be crudely broken down into phases of sleeping/ low activity followed by aggressive hunting; followed again by a dormant period of low activity. As the analogy goes, the longer the alligator sleeps, the hungrier it becomes, and therefore the stronger the subsequent ‘price-hunting’ activity is. This indicator is designed to highlight a trend absence, formation and direction.
As this is made up of 13, 8, and 5 period Smoothed Moving Averages (SMAs) coloured blue, red and green, to represent the alligator’s jaw, teeth and lips. When the alligator is ‘sleeping’ the SMAs are closely intertwined and in a narrow range. If the SMAs are moving in an upward direction (green, red then blue) then this is taken as an indication to buy. Conversely, if the averages are moving downwards with the order remaining the same, then this is considered a sell indication.
Awesome Indicator (AO)
The AO is a momentum indicator which reflects precise changes in the market driving force. It is made up of three signals.
The saucer represents three successive columns above the nought line. The first two must be coloured red, where the second one is lower than the first one, and the third is coloured green and stands higher than the second one. This formation serves as a signal as to where to buy. Conversely, an inverted formation would be a signal to sell.
Nought Line Crossing
This takes place where the histogram crosses the nought line in a upward direction, into the positive values from the negative values. This movement serves as a buy signal, and the inverse of that would indicate a sell signal.
This formation consists of two consecutive peaks which are below the nought line, and the second peak stands closer to the nought line than the previous one. This would serve as a buy signal, and the inverse would serve as a sell signal.
The Fractal indicator displays the local highs and lows of the chart. It highlights the point at which the price has stopped and reversed. They are made up of 5 consecutive bars, the first successfully reach higher, while the last descend lower. The middle bar forms the highest of the group. This can also be inverted so that the middle bar is the lowest of the group.
Gator Oscillator (GO)
The GO indicator is a supplementary aid to the aforementioned Alligator Indicator and is used in unison with it. It is made up to two histograms which are built either side of the nought line. It helps to break down the Alligator’s behaviour into four specific categories: Awaking, Waiting, Filling Out and Sleeping. Depending on which side of the nought line the histogram forms, it signals the absolute difference between the Alligator’s Jaw and Teeth (positive reading), or Teeth and Lips (negative reading). If the histogram’s bar extends past the preceding bar, it is coloured green, otherwise it is coloured red.
Market Facilitation index (MFI) Indicator
The MFI indicates the extent of the willingness of the market to move the price in the market. The histogram bars show the absolute values of the index. It is made up of four colours: Green, Blue, Pink and Brown indicating the various levels of volume and MFI.
The Defensive Trader
This is the bittersweet section that will be your blessing and your curse, should you choose to follow it.
In this book we have outlined in detail all of the essential elements that you need to have in your toolkit as a Defensive Trader. We have discussed numerous times that the successful trader must be able to read a range of different kinds of assets and identify a range of different kinds of market conditions.
It is not an easy charge, however, without developing these abilities, you will never advance form the amateur status where so many let themselves be limited. Mostly due to their lack of ethic than their lack of ability. (See the 80/20 Rule or Pareto Rule). Thus, now that you are aware of the various elements of Fundamental and Technical forms of Analysis you are prepared for the next step on the path.
Irrespective of the asset you are looking at, or of the market conditions (which will only change the RRR levels as discussed in Part 2), the approach to trading safely as a Defensive Trader is always the same. No matter which formations (candlestick, chart pattern or specialist formation i.e. Elliot Wave), or of which indicators you are using, the following rule must always be adhered to in addition to the Risk calculations that introduced in Part 2.
The Defensive Trading Technical and Fundamental Confirmation Trade Assessment Strategy
The Defensive Trading Strategy requires that every trade entered into must be confirmed by three aligned Technical Indications (of your choosing), as well being consistent with your Fundamental point of view in order to warrant the risk of your capital. The Technical Indications come from the various elements of Analysis presented earlier in this book.
The reason this is the key to Defensive Trading is that it is a systematic approach that prevents you from focusing unduly on one piece of information (fundamental) or one reading (technical) and forming 100% of your opinion on what direction the asset is going moving in, on that one thing. It is a process driven and logical way of forcing you to look a variety of factors and readings for every single trade which will, in turn, prevent you from making the mistakes that are indicative of armature traders.
It is slow and can, at times, feel like watching paint dry. However, I ensure you, if you can stick with this approach, you will stick with trading. Because you will be ‘wrong’ so infrequently that you will be profitable. You may have noticed throughout the text that many of the elements introduced had an annotated points value. These are now applicable to the process, which works as follows:
As we have mentioned throughout, the Fundamental elements are so significant that they alone balance three technical indications. It is the indicator of primary focus is always the Interest Rate figure, however, remember that all the other indicators outlined are what contribute to Central Bank’s decision to maintain, raise or cut this rate. From this point of view, any other readings of note are essential to review in order to form an opinion of future direction of the economy, and therefore the likely future actions of the Central Bank.
If you are a good economist, you will often find that you are early on your summation of what direction the economy is going to be heading over the following months. This is very useful and will allow you to be prepared very early to wait for the technical elements to catch up and present to you the very best trading opportunity where all elements are in harmony and agreeance.
Note, however, if no significant fundamental influence is affecting the market (business as usual), this will not necessarily help you in determining the trade itself. This ambiguity in the fundamental direction does not mean that you are therefore precluded from entering a trade if you see the Technical elements line up, it simply means that you are aware that your fundamental opinion at this time is neutral. The reason ensuring that you are assessing the Fundamental characteristics of any given asset is as it is to prevent you from entering a trade in opposition of your fundamental view simply because the technical indications say to do so. You must never do this. Only enter a position when your fundamental opinion on an asset is in agreeance with or neutral to the Technical indications,
Likewise, if you find that you don’t have a particular opinion of an economy, or, cannot recite from memory the most last few Economic releases for it, then you certainly should not be trading the currency.
Technical analysis elements generally easier to assess as they are so visual, you can’t miss them.
Please note that you do not, (and should not) use all of these indicators at once. You may use a maximum of 4 technical elements, but please note, you will need to ensure that this reading is mirrored on at least 2 consecutive timeframes (e.g. daily and 4H chart, or 1H and 30M chart etc.).
You will also need to ensure that the prevailing timeframe is indicative of the duration that you intend on staying in the trade for. Don’t use a 30M chart when you are intending on trading for 2 days, for example.
If you can ensure this, then you should enter the trade with your stop loss and take profit as instructed in Part 2 Trade Plan.
To assist you with this process below is an example for you to use in order to check your understanding before opening a position.
Please review the following charts:
EUR/USD Daily Chart
EUR/USD 4Hr Chart
Elements to Note (see circled areas)
- Pennant formation of consolidation
- Spinning Top Candlestick Pattern
- Bollinger Bounce from lower level
- Stochastic giving an upward movement reading
- MACD giving an upward direction reading
The pennant formation indicates that the asset is likely to make a long-term move further down, however, it is likely to bounce off the upper limit of the pennant before it does so. Therefore, a Buy trade on a short-term timeframe with a target of just inside the upper level of the pennant.
Spinning top candlestick formation at the point that the price bounced off the lower level of the pennant.
Bollinger Bounce off lower level.
The Stochastic is moving in an upward direction, indicating an upward move. In addition, you can see that the indicator is giving a recent reading of higher lows, whereas the price is giving a reading of lower lows. This is known as regular bullish divergence, an indication of upward movement as displayed in the third image above.
The MACD has ‘Crossed Over’ giving an upward movement indication.
From a Fundamental point of view, given that this asset is the EUR/USD, we have to understand both the Euro and US Dollar Economies. In this instance, for the purpose of this example, we will assume that we hold no particular Fundamental view.
EUR/USD 4Hr Chart Summary
The levels that you seek to enter and exit the position at are going to be indicated by the Support and Resistance Charting analysis that you have performed. In this example, as mentioned, as this trade is calculated to be a short term opportunity that will then be followed by a resumption of a downward movement (as indicated by the chart pattern), the target will be just inside the top level of the Pennant chart formation.
The final step in this process is that you need to identify the same reading on two consecutive timeframes that are applicable to your style of trading. Thus, on the 1 Day and 4 Hour charts, or on the 4 Hour and 1 Hour Charts etc. No higher than the 1 day and no lower than the 30 Min.
In the instance that you discover that there are two consecutive timeframes that have conflicting readings, always default to the superiority of the higher timeframe, and wait for the lower timeframe to align with the higher timeframe.
Defensive Trader Rule 1
A reputable Broker is the starting point of your success as a Trader. Make sure you shop around and take an analytical approach to whom you trade with. Check reviews, Terms and Conditions and any additional free services offered.
Defensive Trader Rule 2
Protect your Capital like it is the last dime you have to your name.
Defensive Trader Rule 3
Don’t let your successes let you become too confident and allow you to think that you no longer need to follow the Defensive trading Strategy outlined in this book.
Defensive Trader Rule 4
Never move your stop loss ounce you are in a trade.
Defensive Trader Rule 5
Don’t worry about drawdown, if you have done your assessment correctly, if an asset doesn’t turn to profit immediately that’s ok. Being a little bit early is better than being late.
Defensive Trader Rule 6
Take your profits out regularly, preferably monthly. After all, having the cash is what you are doing this for.
Defensive Trading Trade Plan
Before you can really start analysing a trade, you need to decide on what chart you are assessing based on how long you are planning on trading for.
Fundamental & Technical Confirmation
Only open a trade when you have a very clear idea of where that trade is going. Follow the Fundamental and Technical Confirmation system to ensure that you are correct as often as possible on any given trade.
Determine Profit Target
Once you have noted what you think is going to happen, you can decide what your profit target is for that trade. Refer to prior information on Support and Resistance levels.
Risk Return Ratio
Now you have your trade direction, and your expectation of the realistic reach of the trade, you can decide how much you are willing to risk on this trade. Refer to Trade Size, Volatility and Risk Return Ratio information.
Stop Loss and Take Profit
You now have your target and risk levels decided, determine exactly where you are going to place your stops. Always enter Stop Loss and Take Profit levels on every trade.
Capital at Risk, Trade size
Once the above have been calculated, you can then decide what size you are going to trade in Lots. Take the levels that you have decided on, determine what you are comfortable risking per pip on this trade. Be conservative.
Use the calculator to decide if this trade size is realistic for your capital and adjust if necessary. See Margin and Leverage sections.
Open or Set Trade
Manually Open position if you are present for the level to be hit. Alternatively, this is more likely that you will set a Pending Order as discussed.
Defensive Trading Trade Example
A trader has an account with $10,000.00 in their account.
They have taken the maximum leverage that they are allowed, 1:30.
To continue from our previous example, the trader has been watching the EUR/USD for a few days and has decided that the asset is oversold and wants to open a long position.
From the previous example, EUR/USD is currently at 1.1404.
Let’s break this process down by our trade plan.
1. This trader is happy to let their trade stay open a day or two but doesn’t want it to go for longer than a few days.
2. This trader has assessed their set up by using the confirmation system and is confident that the fundamental position of the asset is in agreeance with the technical indications on two consecutive timeframes.
3. The price is currently 1.1404. this trader thinks that the asset will easily reach 1.1544 (140 pips) within the timeframe based on the support and resistance levels they have identified.
4. As trading condition are not particularly volatile, the trader decides that they would like to use a 1:5 risk reward ratio. This means for this trade they would risk 28 pips to make the 140 they feel the asset can achieve.
5. Now they have decided on where to set their take -profit, (1.1544) and their stop-loss 1.1376.
6. Now because this is a relatively new Forex trader, they have decided that they only want to risk 2% of their total capital on this particular trade. As we recall from earlier: Total Capital x Risk appetite % = $Value of Risk per Trade.
7. That means for this trade 10,000 x 0.02 = $200
8. Now we have that figure, we can calculate the trade size by taking: $Value of Risk per trade / PIP value of risk = Trade Size
9. Following on, that would mean that if we were using a 1:5 risk return ratio:
10. $200/28 = $7.142 per pip, 0.7 Lots, or 7,000 units of currency.
11. In reality, this can be done my trading 7 mini lots on one trade position.
12. Before opening the trade, we are going to make sure that we have sufficient margin to accommodate this trade.
13. Required Margin = Trade Size (units of currency) / Leverage x Market Price
14. 7000/30 x 1.1404 = 266.09
15. Once we are happy with all these figures we need to hurry up and place trade or set our Market Order.
The Ultimate Question – When Can I Become a Professional Trader?
Arguably, the most asked question by people who are new to Forex Trading is: “When can I quit my job to trade Forex full-time?”
One of the most difficult things about this question is that, in stark contrast to almost all other professional fields, you are the one who makes that decision. Unlike a baseball player or ballerina, you don’t have to get selected or cast in the leading role. You have to do it on your own.
The answer to this it really depends on two other key questions:
Am I Consistently Profitable?
This is realistically the most important question of all. Think of it, as you might, any other specialised area of life, for example, driving a car, playing football etc. There is a far cry between putting together a piece of Ikea furniture and building one from scratch. The same logic applies to trading Forex. Let’s try to test ourselves on this question: Would you pay someone who has your profitability to trade on your behalf? If you would, then you are trading very well.
An approximate timeframe for this would be between 2 to 5 years of consistently profitable trading. It is also important to remember that you will need to have a significant amount of capital in order to make the transition. Let’s assume you are making a 10% profit per month on your trading. This means that in order to take $30,000 per year you are going to need a starting capital of $25,000. This is not accounting for tax etc. Of course, the higher the profitability percentage, the less capital you will need, but, remember that even the best of the best don’t even come close to a 100% strike rate.
The fact is the amount of people who successfully make the transition from armature to professional is very low. This does not mean to say that you cannot make a very nice amount of extra cash by continuing to trade while working in some other form of paid employment.
All is states, is that the stats speak for themselves. As the 90/90/90 Forex cliché claims, 90% of beginners lose 90% of their capital in the first 90 days, and of those who manage to get themselves into a position to turn professional, 1 in 6 will fail. Why does this happen? The most common answer is that they are not trading with a system, or if they do a) the system is flawed and doesn’t work against the backdrop of changing market conditions, or b) they do not adhere to the rules correctly and stick with the system long term.
If you can image a Professional trader, they are meticulous about their rules and approach their trading with military discipline. Anyone who does not or cannot commit this level of dedication should be very wary about wanting to follow a career in trading.
For these reasons, the risk management and trade set up confirmation system outlined within this book is essential for the new trader, or the unprofitable trader to follow exactly. If you can commit this level of discipline to your trading, you will be successful long term.
Glossary of Forex Trading Terms
|Appreciation||A currency is said to appreciate when it strengthens in price in response to market demand.|
|Ask Rate||The rate at which a financial instrument is offered for sale.|
|Base Currency||The base currency is that which an investor maintains its book of accounts.|
|Bear Market||A downward market, distinguished by decreasing prices.|
|Bid Rate||The rate at which a trader is willing to buy a currency.|
|Bid/ Ask Spread||The difference between the bid and the offer price, the most widely used measure of market liquidity.|
|Black Swan (Event)||An unexpected event of large magnitude and consequence with a dominant role in history. Such events are considered extreme outliers, however, collectively they play a vastly larger role than regular occurrences. E.g. Coronavirus, 911, Global Financial Crisis.|
|Book||In a professional trading environment, a book is the summary of a traders or desk’s total positions.|
|Broker||A firm who acts as an intermediary, putting together buyers and sellers for a fee, or commission.|
|Bull Market||A market that is trending upwards, distinguished by rising prices.|
|Buying/Selling||In FOREX currencies are always quoted in pairs, so that all trades are the result of simultaneously buying one currency and selling the other.|
|Cable||Trader jargon for the GBP/USD exchange rate.|
|Central Bank||A government organisation that manages a country’s monetary policy. For example, the US Federal Reserve, the Bank of England, European Central Bank, Bank of Japan or German Bundesbank.|
|Clearing||The process of settling a trade.|
|Close||The beginning of a timeframe or trading session.|
|Conservatism||Fiscal conservatism also known as economic conservatism is a political-economic philosophy regarding fiscal policy and fiscal responsibility advocating low taxes, reduced government spending and minimal government debt.|
|Consolidating||When a currency is trading in a range, typically after a large move or before a news announcement which is highly anticipated.|
|Contract (Unit/ LOT)||The standard unit of trading on certain exchanges, the trade size.|
|Currency||A form of money issues by a government or central bank and used as legal tender and a basis for trade.|
|Dealer||An individual who acta as a principal or counterpart to a transaction.|
|Demand||Refers to how much (quantity) of a product or service is desired by buyers.|
|Derivative||A fall in the value of a currency due to market forces.|
|Devaluation||Deliberate downward adjustment of a currency’s price, normally by official announcement.|
|Dovish||Tentative, no committal language regarding future fiscal policy changes, usually by Central Bank heads.|
|Dumb Money||The ‘sucker’ who gets in when the Smart Money is getting out|
|Economic Indicator||Economic indicators such as Interest rates, inflation, GDP, foreign investment, and the trade balance reflect the general health of an economy and are therefore responsible for the underlying shifts in supply and demand for that currency.|
|End of Day Order||An order to buy or sell at a specified price which remains open until the end of the day.|
|EURO||Currency of the European established in 2002 comprised of the|
|European Central Bank (ECB)||The Central Bank for the new European Union.|
|Federal Reserve System||The Central Bank for the United States, responsible for implementing the country’s monetary policy and regulating member banks.|
|Fixed Exchange Rate||Official rate set by monetary authorities for one more currency.|
|Floating Exchange Rate||Floating exchange rate refers to the relative value of a currency as determined by supply and demand.|
|Foreign Exchange||FOREX or FX is the simultaneous buying of one currency while selling another. This market exchange has more daily trade volume than any other.|
|Forward||A pre-specified exchange rate for a foreign contract settling at some agreed future date. Based on the differential between the two currencies involved.|
|Forward Rates (Swaps)||A forward rate refers to a cash price of 2 currencies interest difference for a fixed term.|
|Fundamental Analysis||Focuses on the economic forces of supply and demand that causes price movements. The Fundamentalist studies that causes of markets movements, whereas the Technician studies the effects.|
|Gap||Empty spaces between the close of one candle and the open of another in any given timeframe.|
|Gearing||Known as margin trading. A term used in the relationship of actual equity vs controlling equity.|
|Group of Five (G5)||The five leading industrial nations (France, Japan, Germany, the UK and the US), which meet from time to time to discuss common economic problems.|
|Group of Seven (G7)||Seven leading non-communist industrial nations composed of G5 plus Canada and Italy.|
|Good ‘til Cancelled||An order to buy or sell at a specified price. This order remains open until filled or until the client cancels.|
|Hawkish||Aggressive, bold, direct language usage regarding future fiscal policy changes, usually by Central Bank heads.|
|Hedging||A hedging transaction is a purchase or sale of a financial product, having as its purpose the elimination of loss arising from price fluctuations in the foreign exchange rate.|
|Inflation||An economic condition whereby prices for consumer goods rise, eroding purchasing power.|
|Interbank Rates||The foreign exchange rate at which large international banks quote other large international banks|
|Leading Indicators||Statistics that are considered to predict future economic activity.|
|Limit Order||An order with the restrictions on the maximum price to be paid or the minimum price to be received.|
|Line Charts||The Line Chart connects single prices for a selected period.|
|Liquidity||The ability of the market to accept large transactions with minimal impact on price stability.|
|Liquidation||The closing of an existing position through the execution of an offsetting transaction.|
|Long Position||A position that appreciates in value if market prices increase. When one buys a currency, their position is known as ‘Long’.|
|Margin||The required equity that an investor must deposit to collateralise a position.|
|Margin Call||A request from a broker or dealer for additional funds or other collateral to guarantee performance on a position that has moved against a client. If the equity balance In an account falls below the margin requirement, a margin call will be generated. In the event that an account exceeds its maximum allowable leverage, open positions are liquidated regardless of the size or the nature of positions held within the account.|
|Market Maker||A dealer who regularly quotes both bid and ask prices and is ready to make a two-sided market for any financial instrument.|
|Open||The beginning of a timeframe or trading session.|
|Open Order||An order that will be executed when a market moves to its designated price. Normally associated with Good ‘till Cancelled Orders.|
|Open Position||A deal not yet reversed or settled with a physical payment.|
|Over the Counter (OTC)||Used to describe any transaction that is not conducted over an exchange.|
|Overtrading||A trader’s inability to sit out of trades and wait for real opportunities to present themselves. ‘Has to be in mentality. Leads to blowing up an account and indicates that the trader has no plan.|
|Pips||Digits added to or subtracted from the fourth decimal place, i.e. 0.0001 – also called Points|
|Political Risk||Exposure to changes in governmental policy which will have an adverse effect on an investor’s position.|
|Position||The netted total holdings of a given position.|
|Quote||An indicative market price, normally used for information purposes only.|
|Range||When a currency pair is trading between specific high and low prices during a range of time.|
|Rate||The price of one currency in terms of another, typically used for dealing purposes.|
|Resistance||is a price point on a bar chart for a security in which upward price movement is impeded by an overwhelming level of supply for the security that accumulates at a particular price level.|
|Risk||Exposure to uncertain change, the variability of returns significantly the likelihood of less than expected returns.|
|Risk Capital||The amount of money that an individual can afford to invest, which if lost would not affect their lifestyle.|
|Risk Management||To employ financial analysis and trading techniques to hedge one’s risk.|
|Rollover||The process whereby the settlement of a deal is rolled forward to another value date. The cost of this process is based on the interest rate differential between two different countries.|
|Rollover Rate||The daily rollover interest rate is the amount a trader either pays or earns, depending on the established margin and position in the market. To avoid rollovers, simply make sure positions are closed at the established end of the market day.|
|Short Position||An investment position that benefits from a decline in market price. When one sells a currency, their position is ‘short’.|
|Slippage||Occurs when an order is executed, often without a limit order, or a stop loss occurs at a less favourable rate than originally set in the order. Slippage is more likely to occur when volatility is high, perhaps due to news events, resulting in an order being impossible to execute at the desired price.|
|Smart Money||Big institutional investors and mutual fund companies are labelled smart money.|
|Spot Price||He current market price. Settlement of spot transactions usually occurs within two business days.|
|Spread||The difference between the bid (buy) and offer (ask/sell) prices; in other words, the spread is the commission that the brokerage house makes on each trade. This can vary widely between currencies and between brokerage firms.|
|Sterling||Slang for British Pound|
|Stop Loss (Order)||Order type whereby an open position is automatically liquidated at a specific price. Often used to minimise exposure to losses if the market moves against an investor’s position.|
|Supply||Supply explains how much of a good or service the market can offer.|
|Support Level||A term used in technical analysis indicating a specific price level at which a currency will have the inability to cross below. Recurring failure for the price to move below that point produces a pattern that can usually be shaped by a straight line. It is the opposite e of Resistance levels.|
|Swap||A currency swap is the simultaneous sale and purchase of the same amount of a given currency at a forward exchange rate.|
|Technical Analysis||An effort to forecast prices by analysing market action through chart study, volume, trends, moving averages, patterns, formations and many other technical indicators.|
|Tick||Minimum price move.|
|Trend||Simply the direction of the market, usually broken down to three categories, major intermediate and short-term trends. Three directions are associated, up, down and flat.|
|Trendline||This is a Technical Analysis indicator also called or linear regression, which is a statistical tool used to uncover trends.|
|Volatility||A measure of price fluctuations. The standard deviation of a price series is commonly used to measure price volatility.|
|Volume||Represents the total amount of trading activity in a particular stock, commodity or index for that day. It is the total number of contracts traded during that day.|
|Weak Dollar/ Strong Dollar||The dollar is said to be weak compared to another currency when more dollars are required to buy one unit of another currency and vice-verser.|
|Whipsaw||Slang for a condition of a highly volatile market where short price movement is followed quickly by a reversal.|
This now brings us to the close of our four part curse in How to Trade Forex. Please now continue on in your Defensive Trading education by following on with the Ultimate Course in How to Trade Cryptocurrencies.