A moving averages momentum trading system—trade management and forecasting.

Introduction

Continuing our analysis of the entry triggered by what we described in detail as a system for exploring the momentum of the market, using two timeframes and a set of moving averages, plus the Bollinger bands, part one being [click] here and part two being [click] here.

Stop loss placement and justification

The stop loss order is entered immediately on entry at 5390 as per the previous article, above the 88.6% (maximum) fib retracement of the entry candle on the H1 chart (level marked in red).

Entry timing and limit order usage

The entry at market is at the close of the H1 candle, NB it would be acceptable, and indeed professional, to place either a sell stop entry 1 pip below the close of the H1 candle, likewise a sell limit entry either at the 38.2%, 50%, 61.8% or 78.6% of the H1 candle, for even less risk, though in this case (actually a rarity), such an order would not have been filled.

Initial trade progression

After the entry, there is a dead drop, all seems wonderful.

However, the market is halted for 30 minutes what looks like the 61.8% level of the prior upswing (not marked).

This is followed by lower low, forming a lower high, lower low pattern, promising for our continuation.

Doji candle

There is then a doji candle, just to the left of the ‘E’ in the word entry marked on the above chart.

Lower high progression

Notice that the three candles including the doji and the two to the left of the doji, each have slightly lower highs.

Weak directional closes defined

There are then three upward facing candles, however, each fails to close much above its 50% level – for a candle to be considered bullish, really, we would want to see it closed in the top 25% at least – again a good sign for this trade.

Mini-swing correction defined

Thus what we have is the formation of a mini-swing correction, making up a rectangle potential energy building area, tested several times to the upside, followed by a new swing lower, consisting of three bearish candles,

Three black crows Japanese candlestick pattern

NB. This is also the ‘three black [in this case red] crows’ Japanese candlestick pattern.

As per the figure above, a new M15 swing low is established 2 hours and 45 minutes after entry, as marked by the first red elipse.

Confirmation of swing correction

The swing correction is confirmed by the multiple testing near the entry level forming a region of sideways flow after the entry with a clear top as we just mentioned.

New swing establishment

The break of the low and close beneath it confirms the new swing is being established at the point of the close of the candle whose lower body and wick protrudes through the first red elipse marker

Stop management

The stop can then be brought above the correction high, effectively placed at the break even point.

Chart: 15 minute chart highlighting new swing low formation

Let us look more closely at the targets.

Fibonacci retracements and expansions

In the next chart, we have drawn Fibonacci retracements and expansions using the latest swing down (external Fibonacci retracements), off the back of the swing up before our reversal entry (alternate fibonacci retracements), and finally, by projecting a move that is precisely 200% of the recent upmove, from the top of the most recent pivot high projected downwards, i.e. from the high above the stop loss, to the low before the trade was placed, and beyond by 100% of that move, to include internal retracements.

See the section of the site on Fibonacci retracements, extensions, expansions, and alternate extensions for more information on these.

Price touch of lower bollinger band

As the price continues to drop, it finally hits the new position of the lower Bollinger band on the H1 chart, at 5350.

Cluster of fibonacci retracements/expansions

Thus, we can see a cluster of external Fibonacci lines, using both the most recent swing up which we are deeming corrective, and the most recent swing down, which we are deeming impulsive for the purposes of this trade.

Target of lower bollinger band with fib cluster

As can be seen in the chart, 4 hours after the entry candle, the price reaches the target of the bottom Bollinger band line on the H1 chart – the sensible first target given the sideways trading context on this timeframe.

Sensible flexibility on target

Since this level is 5350, even though the strict 1:2.5 take profit is 5348, it would surely be sensible to accept 5350 as level in itself that is likely to bounce (round 50), which is also the fibs triple cluster area as shown above.

Fib clusters described

Looking at the fib clusters (where levels are almost even with each other), clearly, the 114.6 fib of the most recent downswing is confluent with the 132.8 fib of the prior upswing, which in themselves are in alignment with the lower Bollinger band target – too much to ignore for the sake of a couple of pips.

Notice also how the double cluster of fibs above the ‘Fibs + BBand Cluster’ also acts as a line of symmetry for some choppy market behaviour.

Managing the trade with trailing stops

In spite of many clues pointing to 5350 being a sensible area to make like the wind with profit in our wings, the trade can still be managed using trailing stops as follows.

Aiming for fibs triple cluster

Management of the trade follows the lower timeframe, still aiming for the fibs triple cluster (2.5 x take profit), but locking in profits using a trailing stop method.

New swing low

As per the figure above, a new M15 swing low is established 2 hours and 45 minutes after entry, as marked by the first red elipse.

Correction high

As mentioned above, the swing correction is confirmed by the multiple testing near the entry level forming a region of sideways flow after the entry with a clear top.

The break of the low and close beneath it confirms the new swing is being established from the point of the close of the candle whose lower wick protrudes through the elipse.

Swing trading stop management

The stop can then be brought above the correction high, effectively placed at the break-even point, as per standard swing trading rules.

The trade is now using the market’s money, with risk reduced from 12 points to 0 points.

Target reached

Just a few candles later, the target of the lower Bollinger band on the H1 is reached, and strongly rejected, hitting a triple confluence point.

Confluence zones

The first element of the confluence zone is the Bollinger band H1 lower line as we mentioned.

The second is the 132.8% retracement of the prior upmove, the third is the 114.6% extension of the prior downmove.

Such clusters form likely areas of reversal.

Trailing stop management of the trade

If the trade was not exited for whatever reason at the 2350 level, we are now sitting with a stop at break even, above the most recent correction high, using swing trading rules.

There is now a significant period of consolidation and thin liquidity, mainly due to market hours, which have not been considered thus far, and add to the reasons to have got out at 2350, or at the retrace to 1:2 as a consolation.

However, eventually, the market does create a new swing low as marked by the second red elipse.

At this point, the stop can be brought down to the level just whisker above the candle that did bounce off the original target of the lower Bollinger band, which has formed a correction high.

Eventually, this stop does get taken out at 5360, for a profit of 18 Nasdaq points, for 12 risked initially, that is to say, 1:1.5 eventual risk reward.

There are a number of alternative trade and risk management techniques that could have been employed by the savvy trader.

These are discussed at length in the sections on trading risk management.

Conclusion

In conclusion, we began in article 1 with a rules-based system for describing market momentum using averages, identifying potential reversals in the trend with filters (the Bollinger bands and 20SMA, plus the stochastic oscillator).

We went on to go through a worked example using an operational timeframe (M15) and a confirmatory, higher timeframe (H1) and traced the trade from start to finish, including stop loss, entry, forecasted projections and finally, trade management using either a confluence exit, or trailing stop.

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A moving average reversal, trend and momentum based trading system—example NASDAQ trade

Review

In the last article in this series, we introduced a way to establish intraday momentum on the M15 and the H1 charts, using only moving averages, with Bollinger bands for confirmation of viable trend exhaustion (a reversal).

Let us take the basic anatomy that we have explored and the trade that was identified on the NASDAQ cash index chart, and explore the follow on from that.

We suggested that given the matrix in the previous post, the downward bias can be clearly seen, with the full short term momentum signalling down on the M15 chart, and the first warning on the H1 chart.

Furthermore, recently, the price action had touched the upper Bollinger band on both charts, informing us of a possible trend exhaustion coming up.

Chart setup – M15 and H1

Here are the two charts as a reminder.

Chart 1 – 15 minute chart of NASDAQ cash index

Figure 1. NASDAQ cash index 15 Minute chart.

Signal candle

The signal candle for entry using the system we have built up is the last candle showing on the chart (close of the 1st candle in from the right).

The entry candle has offered a greater price change than any of the preceding 8 candles, and has closed very easily within its bottom 25%, it is a classic momentum down candle, closing also nicely below all three of our short term momentum averages.

Stochastic Oscillator

Notice also that a Stochastic oscillator (14,3,3) has been added and the main line is diverging away from the signal line, and both are pointing downwards, having just breached the 80 level from above, another good sign that we are on the right track.

The downward sloping longer term averages support the directional bias of the trade and add confidence to the entry.

One Hour Chart

Entry, stop and target price

On the one hour chart, we add the entry price, the stop and a 1:2.5 risk reward target to the H1 chart.

Bollinger bands sidways

We earlier noted that the H1 Bollinger bands were trading sideways, in which case, the bottom Bollinger band should be a serious candidate for a bounce.

Price should range between the bands in such a condition.

Entry candle from the one hour chart

Below is the entry as it looks on the H1 chart, the entry being the close of the rightmost candle.

The 3EMA ‘Elbow’

Note the acute elbow-like hook on the 3EMA, which forms our warning 1, given that it closes below the 5SMA on this chart.

One hour chart of NASDAQ cash index

NASDAQ cash index trading strategy

Stop loss

The stop is 12 Nasdaq points from the entry, including spread (5390 VS 5378, respectively).

This level is sufficiently tight, but still above the 88.6% retracement of the H1 candle, what I call the ‘point of no return’.

Alternative stop

An alternative stop would be just above the high of the H1 candle, but no higher, unless we were trading from an H2 chart, which we are not in this case.

Target risk reward level

The ultimate target of 1:2.5 risk reward is conveniently tucked below the current level of the Bollinger band lower line, which we believe will be hit in a sideways market, at level 5348.

We are therefore looking for the momentum to take the Bollinger band itself lower than its current sideways static level, as the market travels down, in order to reach this satisfactory risk reward area.

Trade progression

Following from our previous look at a trade triggered by confluent indications of a downward move starting from the M15 chart, leading the H1 chart and giving a high probability of reaching the bottom Bollinger band, after a reversal near the top of the H1 bollinger bands, sufficient momentum from the moving averages trading system described here.

Let us see the progression of the trade now, using the M15 chart and introduce some more advanced technical forecasting techniques, and visualise the risk management strategy.

Progression of the trade on the 15 minute chart

Complete trade evolution

The above chart shows the evolution of the trade from start to finish, using the operational timeframe, namely, the M15.

This article is continued by using some more advanced technical analysis and trade management techniques.

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A moving average reversal, trend and momentum based forex, stock index and commodities trading system

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Introduction to the first Moving Average Momentum Trading System Series

Introduction

This article is the first of three articles which develop a moving averages momentum trading system, and go through a worked example of a trade that uses multiple timeframes and a systematic approach to the system.

Objectives

Our objectives in this series of three article are:- to define a short term, medium term and long term trend using moving averages.

  • to interpret a reversal of the short term trend using a ‘warning system’.
  • to make a systematic reading of overall momentum and direction using two timeframes
  • to go through a workable trading plan using an example, with clear entry, trade management and exit criteria
  • to introduce indicators that can be used for confirmation of a trade setup
  • to introduce forecasting of viable target areas using bollinger bands and fibonacci confluence clusters

Structure of the series

This post, post one, introduces key concepts and identifies and analyzes a trade setup using a ‘matrix’.

Post two goes through the trade’s evolution from start to finish in simple terms.

Post three examines the trade management and forecasting aspect of the trade.

Moving Averages as Momentum Indicators

Moving averages can operate as useful indicators of market momentum.

Let us define the short term momentum by way of three moving averages, a three periods, five periods and eight periods moving average.

By period, we mean the time it takes for a full bar or candle to form on any time frame.

Using two timeframes

Let’s take the fifteen minute chart as the operational timeframe for the purposes of this article.

And we shall take the one hour chart as the upper timeframe for the purposes of verification.

Let us define the shortest term momentum by way of the exponential moving average (EMA), 3 periods, and using the close price in the calculation.This will plot an average that gives greater weight to the more recent closes.

Early warning system

The 3EMA will closely follow the market.Strong moves in a reversing direction will create an angular ‘shoulder joint’.

Strong moves in a given direction will create a strong unbroken line in a given direction.

The 5SMA will follow the price action more slowly, but faster than the 8SMA.

The short term trend

The 8SMA is our ‘crux of the short term trend’.In other words, its pointing towards 2pm or higher means we are in ‘uptrend mode’.Its pointing towards 4pm or lower means we are in ‘downtrend mode’.

This goes for both the M15 and the H1 charts.

Reading momentum mechanically

Let us take this further and say that:

  • When the 3EMA crosses the 5SMA from above to below, this is the first warning that the market trend may be moving from up to down.
  • When the 3EMA crosses the 8SMA from above to below, this is the second warning that the market trend may be moving from up to down.
  • When the 5SMA crosses the 8SMA, and the 8SMA is now turning down, this is the third warning, and the confirmation that the trend may have moved from up to down.And vice versa for down to uptrending market in the short term.
  • We have thereby defined by rules an uptrending market in the short term.

    The backbone of trend change

    For potential reversals back to the initial trend before the short term change, let us consider the 20SMA as a support/resistance, particularly when it is pointing in the direction of the longer term trend (2pm or 4pm).

    Thus the 20SMA is a filter for false short term trend changes, or alternatively, defines for us that a short term trend change is a correction, rather than a fuller trend change.Support and resistance – medium term trendFor medium term trend, let us consider firstly, whether the price is trading above or below, and secondly, the slope of the 50SMA.Let us consider the 40SMA as ‘pre-warning’ support/resistance.

    Long term trend

    For the long term trend, let us consider the 100SMA and 200SMA – what is their slope, their relationship to each other, and finally, the relation of the average to the current price.Finally, let us introduce a pair of Bollinger Bands, set at 20 periods for the 20SMA in the middle, and two standard deviations either side of the 20SMA to give the upper and lower bands.The Bollinger Bands, if flat, indicate a sideways trend from one side to the other.

    The Bollinger Bands, if sloping, give a price level to consider the market as overbought (look for our reversal) when considering the upper band, and vice versa for the lower band, also looking for our reversal warnings and confirmation.

    How to read a momentum based moving average strategy summary

    We now have a complete system for defining the momentum of the market using moving averages.We have a short term trend defined by the slope 8SMA, with warning guidance of a change indicated by the 3EMA and the 5SMA.Above the 8SMA, the price is in long mode.

    Below the 8SMA, the price is in short mode.

    Above the 20SMA, if the 20SMA is sloping up, we are still in long mode, but assuming a correction to the 20SMA, if the short term trend is indicating short.

    The 40SMA and 50SMA offer support and resistance and tell us the medium term trend.The 100SMA and 200SMA offer support and resistance and tell us the long term trend.We are using an operational and upper timeframe.

    Matrix of possibilities

    Let us consider a matrix of possibilities as to what we may be seeing on our charts in the following two example figures.

    Figure 1. NASDAQ cash index 15 Minute chart.

    NASDAQ M15 chart

    Figure 2. NASDAQ cash index 1 hourly chart.

    NASDAQ H1 chart

    Figure 3. Matrix of possibilities.

  • Slope refers to pointing up or down.
  • Price relation refers to whether price is trading above or below the average and to what extent.
  • Direction refers to confirmed up or downtrend, warning 1, warning 2, or warning 3.
  • Of course, the granularity here is crude, in fact binary, but fit for purpose for this article’s illustration.

    TIMEFRAME 3EMA 5SMA 8SMA 20SMA 40SMA 50SMA 100SMA 200SMA
    M15 – slope DN DN DN UP n/a UP DN DN
    H1 – slope DN UP UP FLAT n/a DN DN DN
    M15 – price relation DN DN DN UP n/a UP UP DN
    H1 – price relation DN DN UP UP n/a UP DN DN
    M15 – warnings (DN) (DN) (DN)
    H1 – warnings DN (UP) (UP)
    M15 – reversal DN
    H1 – reversal DN
    Bollinger band sideways or slanting – M15 UP
    Bollinger band sideways or slanting – H1 SIDE
    Bollinger band touch – M15 DN
    Bollinger band touch – H1 DN
    M15 – conclusion 14 DOWN signals; 5 UP signals = 73.6% down
    H1 – conclusion 11 DOWN signals; 7 UP signals + BBands Flat = 61.1% down
    OVERALL CONCLUSION / TRADE IDEA The crude bias is down and the M15 is offering a leading trade, established short term down momentum, with the H1 3EMA warning now in place. With the H1 Bollinger Bands being flat, the logical extension is to the lower Bollinger band on the H1 chart. At this point, due to the sideways nature indication, the lower time frames should be used to trail the stop according to swings (trade management 1), aiming for the 1:2.5 risk reward. Alternatively, 60% of the trade can be closed (trade management 2), with the stop then brought to breakeven, again aiming for the 2.5 risk reward. Or both management methods can be employed (e.g. Close 75% of the trade, trail the stop with the remaining 25%).

    Conclusion

    By utilising a number of moving average indicators, we can define the market’s trend context in the short, medium and long term, and identify changes by way of pre-defined rules based on a limited number of parameters.

    In the next articles, we will trace this trade through from start to finish.

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    US-China relations and their implications for stocks and the US dollar

    In view of the above headline and keeping things succinct, I am of the view that Trumps diplomatic incompetencies and thus his seemingly constant and deliberate faux pas, not to mention his proposed foreign policy on trade with China and Mexico can mean only one thing and that is much higher costs for American businesses. As a result, I believe that the bull market in stocks which, inconsiderate of corrections, since 2008, has had its day and will begin to correct seriously in this quarter, if not then in the next quarter. This is just a view I am forming, it in no way constitutes investment advice or even education, this is a blog, not a bank.

    However, in light of the above view I will be looking for significant technical reversal signs in stocks. I received Fidelity‘s 2017 outlook this week and that is bullish on equities, bearish on bonds for the whole of 2017. I guess only one of us can be right on this!

    Also, like Jimmy Young, I am now bearish on the US dollar. Dollar rallies are showing a significant possibility of having had their run most major currencies, barring perhaps the loonie (US dollar, Canadian dollar pair) could offer short term opportunities as of next week, in my view, to sell the US dollar.

    Here are some possible strategies for trading based on the technical assumptions below each graph and the talking down of the dollar from Trump’s words of last week.

    Australian dollar US dollar

    Here is the aussie dollar vs US dollar

    Been in a strong uptrend for about three weeks now, the aussie gaining ground agains the US dollar and has broken and taken out stops above the most recent swing high on the daily chart. I do not like the fact the stochastic oscillators are overbough at the moment, although I do see the 60% and 100% extensions of the most recent swing down as potential targets. Friday finished indecisive. The only strategy on offer to me, is to either buy on a dip, or wait for a breakout of Friday’s high, so there’s nothing immediate to me there. The bias is long though.

    Oil (WTI CFD)

    Oil has had a volatile run up from 43.65 early November and is topping out at around 55.80. A stronger close on Friday, but did no close above Wednesday’s high, although penetrated above it during the day. It has nicely ‘turned up’ its 8 simple moving average, and the 20 moving average will continue to turn up on a higher close. There is also a series of higher lows over the last two weeks. I would certainly consider buying the 50% retracement of Friday’s candle, particularly because it is confluent with the 8 SMA. A stop below Friday’s low would require a clear break of the 20SMA to work, similarly a stop below the low of either last week, or the week before. The problem with the wider stops is that for decent risk to reward, that would require taking out the last two major highs of early December (the candle after the gap) and the one mentioned earler.  Clearly oil is making significant swings up and down, I don’t fancy taking a direction on it, except to look at the possible entry mentioned, possibly with a tighter stop based on a lower timeframe.

    Great British Pound vs US Dollar (Cable)

    Huge day on Tuesday with May’s confident Brexit speech which sounded softer at first with its talk of integration and community in my view. Huge gains were to be made on both this pair and the cross pair pound-yen (GBPJPY) below. There is a bit more steam and room left on the oscillators. The pair was also boosted by Trump’s dollar weakening statements and the inaugural speech which seem to make investors flee the dollar on immediate reaction (and buy anything including gold, euro and pound). Again, I think there is room for a further leg up, but nothing screaming at me right now to buy the pair, mainly due to those looming averages the 40 and 50 SMA in turquoise. A clear break of the high of the Brexit speech day (Tuesday) leaves the upper Bollinger band to contend with and the 200 SMA, technically on this chart, but it would be a new swing upmove clearly in play. Certainly one to watch and again, long bias against the dollar. A possible high risk buy on a break of the two averages and the high 3 weeks ago or so. Not too appetising for me though.

    Here is the:

    S&P500 index

    Here’s where I am thinking the stock market hasn’t much left in it. This view gets annihilated as soon as there is a break higher of course, but it has been flat for about 2 weeks after a limp attempt to go higher, then was attempting to breakdown a few weeks ago. Plenty of bearish divergence on the two oscillators. I won’t sell the index, but given gold’s ascent, I think that stocks ought to follow in the reverse direction, with the start, potentially of a major bear market.

     

    USDCAD

    This is the best chart of the lot in my view. It is a weekly chart. Taking the trend to be the upward channel for now, there has been a clear break from zone 4 into zone 3 this week using zone channel analysis and a strong bullish reversal candle. Therefore, looking for opportunities to re-enter a long dollar, short Canadian trade on a 30%, 40% or 50% retracement of last week’s candle is a thought, but bearing in mind this is a weekly chart, position sizing managed accordingly to give a stop below the weekly low, or look for something on the daily or H4 chart to work with in this regard.

    The second chart shows the retracement levels for entry, namely the 40%, 50% or 60%. It is worth noticing the zone 3 line as well. The lower the retracement chosen, the lower the risk in point terms, yet the lower the chance of actually getting a retrace that far, to that level.

     

     

     

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    2 bar reversal

    This post follows part 1 of the series on 1,2 and 3 bar reversal patterns.

    Of course, we could say that the a 2 bar reversal means a break lower than the low of the previous bar, after two consecutively higher lows, higher highs and higher closes. This is one definition of a 2 bar reversal (indeed it will be the definition of a 3 bar reversal in the next post in this series – in case you can’t wait).

    However, we will make it quicker to define a 2 bar reversal.

    Very simply, in an upmove, a 2 bar reversal means the price goes below the close of the bar before the previous in a situation of 2 higher highs and higher closes.

    In a downmove, a 2 bar reversal means the price goes above the close of the bar before the previous in a situation of two lower lows and lower closes.

    Simple and effective rule.  I will add some images later.

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    Gold and Aussie updates

    Both Gold and Aussie have reached their targets with not much sign of abating. Here are the update charts.

    These relate to this post on trading the Aussie dollar and this post on gold trading.

    Firstly the Aussie dollar you will recall the entry from this post on entry signal for Aussie dollar US dollar.

    This outcome has been powerful following that trend and from buying a new entry into zone 3 (NB the zones have been marked slightly off, the numbers in the chart – 1,2,3,4 should be LOWER down within the respective channel).

    Follow up to channel trading Aussie

    We will go through each part as a summary.

    Firstly, we were looking at waiting for a retrace into zone 4, followed by a strong reversal back into zone 3. This occurred 21 candles from the right, counting left (see the first image – I have redrawn the channel lines so they may be slightly different).

    We said it is worth waiting for a 40, 50 or 60% retrace of such an entry candle and this occurred during the next candle, giving us our entry.

    A possible first target then becomes the top of zone 2.

    Note, there are other possibilities for targets. For instance, you could use the level of ZONE 2’s top and ZONE 1’s top AT THE TIME OF ENTRY for alternative (and more conservative targets.

    The stop marked on image 2 is a sensible position to put the stop, underneath the most recent swing low. It could also follow a break of say 10-15 pips below the channel bottom. I prefer the swing low stop, because sometimes the market will spike below a channel, but then close back inside the channel to and the channel may remain valid.

    Target 2 is the level of the top of zone 1.

    It can easily be seen that the risk:reward ratio for this trade no matter which target is outstanding. Getting it right only 40% of the time if aiming for target 2, would yield a profitable result if consistently maintained over the long term.

    The stop loss: 35 pips (30+2 spread+3 slippage)

    The take profit at each target and risk:reward ratio

    T1: 55 points profit vs. 35 pips potential loss. = 1:1.5 risk reward

    T2: 100 points profit vs 35 pips potential loss. 1:2.85 risk reward

    100 trades at 1:2.85 risk reward, with 60 incorrect (40% success rate)

    = -1(35 x 60) + 1(100×40)

    = -2100 + 4000

    = 1900 pips (net profit).

    As for the gold trade, this has also reached the extension target mentioned in the earlier post.

    Here was intial trade call – NB I was sick over Christmas, hence the use of a mobile app image.

    Daily gold chart – buy on the close of the day after the first retrace day of a strong upmove

    Here was the first follow up image, including a target area for the extension.

    Gold Daily – has followed though from Quantisi Ltd’s entry.

    And here is the result, I am delighted to present:

    Let’s go through this post-analysis.

    Firstly, we’ve been through the entry several times, I suggest going back over the previous posts on gold for the entry.

    I’ve added into this chart the possible options for stops we could have used. I opted on a discretionary basis for the option 2 stop or thereabouts, essentially in case of a nasty spike down at a higher level, which did not occur. Therefore, I had to scale down position sizing in order to be able to reasonably accept the potential loss of the stop, unfortunately, but that is the nature of discretionary decision making.

    Stop options 1a, 1b, and 1c would have meant that the market had to take out the low of the day prior, the day prior to that, or 3 days prior to the entry candle, again all reasonable and increasingly liberal places to put a hard stop and effectively, accept a loss.

    None of these stops would have been hit.

    Target 1 is not an unreasonable first target to aim for because it is a hit of the top Bollinger Band. These bands are simply an extension above and below the 20 day simple moving average. The distance from the moving average above and below the bands are 2 standard deviations of the price during that 20 day period. These are the standard settings. Assuming normally distributed prices around the moving mean (the simple moving average), the price ought to stay within the bands approximately 95% of the time. Therefore, when the price hits or exceeds above or below the bands, it can be a time to look for reversals. There are notable exceptions to this, just as there are notable reasons one might consider ‘obeying’ the Bollinger Bands. We’ll go through this in another post.

    As can be seen, yesterday and today, the extension target (2) has been hit at 1200. Although there are chances of gold going much higher, I will be coming back to gold later now this trade cycle has completed itself.

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    Channel Analysis for AUDUSD

    A possible trade on the Australia dollar vs US dollar pair could set itself up next week. It would require the intraday momentum of Friday to SLOW in the downmove in the pair and a reversal to set itself in motion. This reversal would need to keep intact the channel in the image below.

    The ideal scenario would be a spike down into the ‘bounce zone’ marked green, followed by a clear 1 bar reversal, or some other potential reversal pattern, including 2 bar reversal or an outside bar (these will be covered in later posts).

    In terms of explanation, the spike off the topmost channel (zone 1) line set in place that channel line and the bottom channel line is drawn in from Bank Holiday Monday 2 January.

    The first thing to note is that the pair on this chart (H4) is in a clear uptrend, therefore, using this channel methodology, I’m only looking for opportunities to buy.

    I’ve marked the buy zone clearly, and we’re coming into the bounce zone now.

    Note the price has bounced off the 20 simple moving average (dotted line), and this line is pointing nicely upwards still, although the 8 simple moving average, as I have mentioned, a crucial indicator of the current chart’s trend, is beginning to turn down.

    A strong reversal back into the 3rd zone might indicate a buy. Better yet, a test and hold of the bottom zone (zone 4) and a reversal back into the 3rd zone would confirm the channel is still a good play.

    At the moment there is a clear break of the strong uptrend in play, both the triple top and a trend line break (as such a sell), so it will be a case of patiently waiting to see whether the channel is able to contain the downmove, and looking for a strong sign that the uptrend will continue, or seek its previous highs.

    Further opportunities to rejoin the uptrend, or enjoy a bounce exist lower down and are marked by the retracement % levels and the orange dot.

    The 200 SMA (purple) is still pointing down but has lost some momentum, similarly, the 100 SMA is pretty much flat, so if we do get momentum upside, I don’t see a big problem with breaking the 100 SMA (pink) on the next attempt. The 50 SMA (turquoise) is pointing up, hence its being marked as support.

    The trade(s!!).

    Buy. On the upside, looking either for a reversal back into the buyzone from here, or preferably the market dipping lower, then reversing back into the buyzone for a buy, stop will then go 10 pips below the bottom channel line (probably by this point, this will helpfully also take the stop below the 40% retracement area and aiming for 1:1, or the 100SMA, or beyond on the assumption of the trend continuing.

    Sell. Having talked about the buy trade, the most obvious immediate trade is simply join the downmove for now (sell), with a short term stop above the high of the current candle, perhaps aiming for 100% of the length current candle, for a 1:2 risk reward, or just under that. This would mean the price going down to the low of the current candle, and extending a further 50% of the length of the current candle.

    To contend with are: the 20SMA already mentioned, and the 40% retracement area marked. The price might struggle with the 20SMA as it already has acted as support. Possibly one to use half the normal number of lots, due to the trend being an upward one in terms of the most recent sustained strength.

     

     

     

    Coming soon... signals every day. Pepperstone Group Limited

    USD Index has fallen as predicted – the opportunity to buy currencies against the USD

    The post on 16 December suggested a corrective USD index and to watch for opportunities to sell the dollar against major currencies.

    Referring to the above mentioned post and this graphic:

    This played out as follows.

    As can be seen, the index did go lower, not quite reaching the point of the triangle drawn in, and not without a spike higher, however, the time the price took to go down ‘pulled’ the triangle rightward, and the price did end up following the line of the third quadrant line from the first image.

    The USD then provided several tests of the high to the left of the orange and pink square in the above chart, exceeding the price, but not following through, finally this week the USD index giving ‘cross board’ dollar weakness and really strong performances of currencies vs. the USD (see below)

    forex currency pairs daily charts
    Various currencies and the USD Index. Click the image to enlarge.

    As can be seen above, yesterday showed strength and there was no indication on any of the pairs (or the index) of a reversal, and today followed through. In future, I will try to catch these kind of moves before they happen and post a prediction in advance of the trade.

    It can be seen that after the correction from the first two images, there were actually three further highs, a sort of ‘quadruple’ top pattern which is unusal (double and triple tops are more common). What happened in dollar index was probably a kind of variant ‘triple top’, or two double tops, then the first day sell off of the dollar (yesterday) and the second day sell off (today) can be seen clearly as a big red candle, followed by a gap and another big red candle.

    Tomorrow is Non-farm payroll day which can create short term volatility havoc and even be trend changing. It is unlikely we will trade tomorrow, rather let the volatility traders do their thing and work out a strategy for Monday over the weekend.

    There are no immediate signs of this USD selloffs abating particularly, but there are resistance and support offered by the lines on the charts above, and the market will, with little doubt’ be revisiting the mid-points or the 40%, 50%, 60% retracement levels of the daily candles that can be clearly seen – a tip I learned (as I owe a great many of these insights to) from Phil Storer of the commodity trading firm Dillon Gage in Dallas, Texas who wrote this excellent book a few years ago.

    So I am not expecting much follow through tomorrow, probably quietness until the non-farm payroll, in which case we could see a tremendous completion of this dollar selling pattern (a third big daily candle on each of the pairs), or a correction day, or very little if the numbers are as expected.

    If I had to take a direction, I would favour the continuation, but prior to the news and during the news, it is a casino gamble as to what will happen tomorrow, therefore, staying flat (no trade) is a way to protect capital and achieve long term growth.

    In such times I am reluctant to join currency moves that have been missed and rather wait out for clearer opportunities.

    In the words of Phil Storer (mentioned above) – there are an infinite number of trading opportunities but a finite amount of capital  -protect the capital!

     

    Coming soon... signals every day. Pepperstone Group Limited

    Gold has followed through nicely

    This post about buying gold is due a follow up now that three trading days have passed and we are into day 4 of the trade. The trade went in favour of the analysis posted and the entry point of Friday’s close.

    The market did behave with great volatility on Monday evening and Tuesday morning (Monday was a bank holiday so the market opened only at around 6PM Eastern time on Monday 2nd January).

    Thankfully the wide stop mentioned in the previous post meant that volatility did no harm and the move has since followed through in a majestic fashion, hitting the 1:1 risk reward target with relative ease and looking at the chart below, I would argue bringing a stop now up to the low of today (a few ticks below that), taking profit, or bringing the stop to break even for a ‘risk free trade’. after banking 1/2 to 2/3 of the trade.

    1187.75 of so is the 1:1.5 target.

    1200.00 is the 1:2 target.

    I initially figured 1:1.5 is the one to go for, and I think it is reasonable, but want to lock in much of what has been gained so far as well now 1:1 has been hit, a discretionary decision I may regret.

    The ‘extension target’ is only the first target upwards, it is by no means a limit on how far gold could go.

    Harry Dent’s gold analysis I found a little alarming on this matter, perhaps why I have erred towards caution throughout on this. It is important to think independently though.

    I have added potential further targets, the entry and the initial stop to the chart below.

    Gold Daily – has followed though from Quantisi Ltd’s entry.
    Coming soon... signals every day. Pepperstone Group Limited

    1 bar, 2 bar and 3 bar reversals, part 1

    Learn these three patterns. Learn these three patterns. Learn these three patterns.

    I say this three times because being able to read charts is a very important part of my trade plans and trading education. There needs to be a clearly defined ‘reversal’ signal.

    It doesn’t matter if it fails, so long as there are rules to identify it firstly, and identify also when the pattern has failed.

    Spotting potential reversals needs to be systematic in financial markets trading, it cannot be guesswork.

    Traders often recommend trading with the trend, and not trying to spot reversals.

    This is great provided you know how to spot and verify a trend, however it is misleading, because you should really try to get in on the trend itself on a reversal, unless one is only trading breakouts (i.e. Swing trading), but even if swing trading, a reversal can give a good hint either that the breakout is imminent, or that a correction is either starting, or is over.

    Traders, educators and so called gurus will often tell you – buy on a corrective dip. Or, ‘wait for a retracement’… so how do you know when the retracement is over then?

    They did not tell you that. Here, we will go through it so never again will we have to worry about not being able to spot reversals.

    Equally important is learning when to recognise that a reversal has failed. We’ll cover that too. We will do this systematically, in a rules-based fashion.

    The 1 Bar Reversal

    Firstly, the 1 bar reversal pattern. One cannot trade and live without understanding this crucial pattern in trading. It is so simple, yet most traders do not even know about it.

    Very simply, a 1 bar reversal takes place when the market trades above the most recent high (the high of the last bar or candlestick). Then the market retraces back below that recent high, and beyond the close of the previous bar/candle and closes for the time period being measured.

    OR. The market trades below the most recent low (the most recent candlestick or bar’s low), then closes at the end of that time period above the low of that previous candle, and indeed above its close.

    This is a 1 bar reversal and it is a warning that the market could be changing direction. The beauty of this pattern is that it can be applied to any timeframe, and any instrument at all. I tend not to take them very seriously below a 30 minute timeframe, though they can be deadly accurate on 5 minute and 15 minute timeframes as well.

    Here are some examples of 1 bar reversals on a chart of the US dollar vs Japanese yen currency pair.

    forex trading 1 bar reversal
    Examples of 1 bar reversal candlestick

    An arrow below (green – buy) indicates an upside 1 bar reversal.

    An arrow above (red – sell) indicated a downside 1 bar reversal.

    Successes and failures

    In each of these examples, the criteria mentioned above are met.

    It is worth studying the difference between a 1 bar reversal candle, and a candle that does not qualify as a 1 bar reversal.

    As you can see, some of the 1 bar reversals work and are followed through in the price action of the market and are thus forex trading strategy opportunities.

    Others fail, the market simply reverses again either straight away or soon after.

    The point is that this pattern give a clue that the market might be reversing.

    There is an exception pattern I will mention. This is an ‘almost’ 1 bar reversal. These have a long wick (that is to say that the high or low is reasonably far from the close, leaving a long thin line either above or below the close portion of the candle body). They fail to meet the precise criteria, because they don’t CLOSE below the previous close (downside reversal) or above the previous high (upside reversal), but may follow through as a reversal in the same way.

    An example would be the candle that is two forward in time from the second green arrow from the left on the above chart. As you can see, it has a decent wick, closes quite a bit higher than the low, closes fairly close to the close of the previous candle, and is followed, eventually by a dramatic upmove. It is worth noticing these as well, therefore.

    What about applying this knowledge?

    Firstly, they are not for using alone. This is like a spanner of a certain diameter in a toolbox. Other tools are needed, and it is not much use without something to screw or unscrew.

    Nevertheless, we can look at the principles.

    Here is how 1 bar reversal pattern can be used.

    There are four very important price points to note.

    Firstly, identifying the 1 bar reversal. We have just done that. The signal is confirmed once the candle has closed, either on the rule, or judgement  based on the ‘exception’.

    Secondly, the high/low and the close of the candle before the 1 bar reversal. The high is to be noted for a reversal to the downside (red arrow). The low is to be noted for the green arrow signal.

    Why? In the case of an upside 1 bar reversal, if the price after opening above, moves below the low of the previous candle before the reversal, it could be an early warning sign that the pattern is going to fail. It is not a good sign at all.

    Thirdly, the high/low of the reversal candle itself.

    Why? A breach of this level generally suggests that the pattern has failed. It doesn’t mean the price is going to continue against the trade necessarily, but it is a good sign it will and it is certainly a sign that the indication of the reversal has been misread for other reasons, or simply the randomness of the market has gone against the pattern as it appeared – such failures must be accepted and risk controlled accordingly.

    Fourth the 40%, 50% and 60% retracements of the reversal candle itself.

    Why? Quite often the price will go back and test these levels before the reversal comes into play. Therefore, they provide excellent entry points for the reversal trade, allowing for a better point of entry, and accordingly less risk in terms of the raw number of points, ticks or pips between the entry price and a proposed stop loss order.

    Trade. Buying (selling) the reversal.

    Let’s take the fifth arrow in as an example (4th green arrow from the left). This 1 bar reversal as you can see, follows two very small candles, a possible sign that something big is going to happen in the market. Such indecision often precedes a clear play in a direction.

    The first thing to notice is that it has made a new 4+ hour high, this is a good sign.

    The second thing to notice is that it is itself a reversal candlestick of the Japanese candlestick pattern variety (hammer style). These are reversals of themselves, but aren’t very reliable on their own in my view.  And it is not a very classical form of this hammer either. So I am not worried about it going back down too much off that information.

    3 methods of entry

    1. After the reversal candle closes, a decision is made that the signal is to buy. Buy immediately. This means confidence of the price simply continuing to go up, good if it happens. If not it could mean more loss in terms of points or pips than waiting for a retrace, so it is very important to factor this in when considering the size of the position to be taken and whether or not the trade.
    2. After the reversal candle, the trader decides to wait for a retrace, for example, to 40%, 50%, 60% (or some other retracement) of the reversal candle. In other words, wait for the market to come back on itself, then place the deal in the opposite direction, getting in at a better price, and also allowing a tighter stop loss order. The downside of this is that the price may not retrace – as in this example we are now mentioning.
    1. Pre-empting the entry. I only do this if the reversal candle in the case of a upside reversal, while it is forming, goes beyond the candle prior to the prior candle’s low and close. In other words, look back two candles, if the reversal candle has gone lower than the low at time minus 1, is now higher than the previous close (again at t minus 1) AND is higher than both the close 2 candles ago – t-2 – (and by default the low of the candle two candles ago) it may be an opportunity to ‘pre-empt’ the entry, but only under favourable conditions that won’t be covered in this post.

    3 methods of exiting

    The stop loss suggestions below are also significant (that’s why I suggested that these various levels ought to be noted, i.e. one needs to be aware of them). These assume the reversal is to the upside, the opposite is true for a downside reversal.

    1. Tightest stop loss. A stop is placed 2 pips plus spread below the CLOSE of the candle PRIOR to the reversal candle. This assumes that the reversal candle has closed above this close.
    2. 2nd tightest stop loss. A stop is placed 2 pips plus spread below the LOW of the candle prior to the reversal candle. This assumes that the reversal candle has closed above this close. If it has not done this, it should immediately raise a red flag that the reversal might fail anyway.
    3. 3rd tightest stop loss. A stop is placed below the low of the reversal candle itself.
    4. Any lower than this stop and the pattern can be said to have failed, however, it doesn’t mean it won’t succeed e.g. A couple of candles later, but usually with another reversal candle a little lower than the first. If the trader is really convinced he has he directional change right, and can find a suitable stop ensuring the target is at least the same as, and preferably double or more than the proposed stop loss level, it is feasible to have a protective stop lower than the low of the reversal candle, but this should be in only very rare cases.
    5. Examples of entry and exits

    E1 is the entry buy on the close of the reversal candle (second green arrow marked) – note the first reversal candle marked was a failed reversal.

    E2 is a planned entry at the 50% retracement – note that in this case it would not have been filled.

    S1 is the OPEN of the candle 2 prior to the reversal candle. It could be used as the most conservative stop loss area, and also the first sign that the reversal might fail.

    S2 is the low of the prior candle to the reversal candle. This is the first clear sign that the reversal could fail.

    S3 is the low of the reversal candle itself. A breach of this level is a serious sign that the pattern has failed.

    Each of these three levels progressively increase the chances that the reversal is going to fail, and trades need to be managed accordingly.

    In the illustration above, the first reversal fails, because the price goes below its low after the reversal.

    The second reversal candle (which is also a bullish engulfing candlestick) leads to a strong trend in the direction of the reversal.

    A strong reversal can be identified without any indicators in this way – with the bullish signal of the engulfing candlestick and the 3 bar reversal which occurs concurrently.

    However, it is much better to have other indicators to help ascertain in particular, the momentum and trend of the market.

    Notice that candle that fails, although a so-called ‘spinning top’, closes only marginally above the close of preceding candle.

    This is why it is great if the reversal candle closes well above the open of a 2 candle prior bearish candle (for an uptrend reversal), because this can add an extra layer of protection, as the warning will be given of failure if the open of that candle is breached.

    Coming soon... signals every day. Pepperstone Group Limited