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.

 

 

 

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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!

 

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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.
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Investors bought gold for Christmas.

Buy gold?

Straight answer. In terms of Quantisi Funds’ books – yes – but this is educational and not investment advice, please note.

Daily gold chart

We have looked at the USD weighted currency basket index, some currency pairs like USDJPY and now let’s take our first look at the commodity gold, ever popular as a place of safety and growing value for investors.

My theory is as follows, and it could be completely wrong. This post does not constitute trading advice, investment advice or a recommendation. It is purely for educational purposes.

Based on what we have looked at so far, let’s look at the Daily chart for gold vs the US dollar over the last month or so, focusing in on what happened over Christmas week, and I will share my trade, before the result, and then we can see if I had the ‘Golden Finger’ on this one later.

Note that because of controlled risk management, it really does not matter a jot whether this trade works out, unless, e.g. a few billion tonnes of gold fall out the sky and the price of gold experiences such a terrific downfall that my stop order won’t get filled.

Why do I call long gold? The crystal ball bit first. Stocks have been rallying to all time highs since 2008 and particularly since Trump. Yet he is making diplomatic faux pas left, right and centre and suggesting policies that won’t be good for trade with China, a major trading partner for the US. Companies will suffer, so I am assuming some correction in stock markets in Q1 2017. This story supports my gold trade if economics and stock markets do follow this pattern as a bear market in stocks will see finance going into traditionally safer assets, like gold.

But for the most part this trade is technical and it is also strictly contrarian. Firstly, take a look at the chart above.

Clearly, since about September, gold has been in a strong downtrend. There was a spike up on US Election Day, but after Trump was elected, investors have continued to be selling gold (and buying stocks). We have now come to year end and clearly there has been some profit taking by speculators.

What I find particularly interesting is the fact that the last week (Christmas week) has been the strongest week in just over one month for gold.

Go all the way back to the spike and trade the price action forward and you won’t find a stronger series of days for gold than Monday to Thursday of last week.

There was also news out that a sizeable order (to the tune of around $3.5 billion) was placed at the close of play (10pm Eastern time) on Thursday.

It is quite likely that investors will have rushed in on that on Friday only to be disappointed by the lack of follow through on Friday.

Here is where patience could pay off – Quantisi Ltd placed a pending order at the 50% retracement of Thursdays candle.

If the price would have continued to run away, the trade would have been lost. In this instance, the market on Friday retraced almost to the tick, to 50% of Thursdays range.

The idea behind this trade is that there has undoubtedly been a strong move up. We’ve waited for a retrace but are expecting a continuation of that upmove, based mainly on the strength of the move last week, perhaps backed up by the very general crystal ball on stocks and the mysterious big order as well, but mainly the principle that the market tends to repeat itself and a move up may well be followed by another move up of a similar distance, for instance.

This is a contrarian trade, for sure though. All of the average lines on the chart pretty much are pointing down and the trend has clearly been down. But, crucially, the 8 simple moving average has certainly turned up it would appear and will undoubtedly offer support (the white line on the chart). The fact that recent price action has ‘turned this average up’ could well be a clue to a change in trend…

It is always risky ‘guessing bottoms’ on the other hand, but in some sense this guess is educated and one must take a risk in order to gain a reward.

Stop loss placement.

The first logical place to put a stop is below the low of Thursday’s candle, then Wednesday’s, etc.

I am confident of a follow through (else why take the trade) but not confident enough to risk more than is comfortable. At the same time I want to give the trade plenty of room, without giving it so much room as to absorb unnecessary losses when the idea has clearly failed.

I have therefore placed a stop below Monday’s low (the weekly low of last week) and am targeting 1.5 to 2 times the distance from my entry to that stop loss, to the upside, at least. I have had to scale down my position size accordingly.

If the trade really gathers steam though, I think with some volatility on the way up, it could see 1250.00 in an extended move, at least. For now though, I want a conservative 1:1.5 risk to reward to be hit and then I can consider options for scaling up, locking in profit, risk free trade and so on.

There is plenty of resistance above (pretty much all that spaghetti on the chart could act as resistance).

But, it is a New Year and last week has suggested renewed interest in the commodity. It should be interesting to see how this trade plays out, with any luck, highly profitably. To be continued…

An interesting article to go alongside this post is here:

link:

http://www.sputniknews.com/amp/business/201701021049196920-china-gold-market/

 

 

 

 

 

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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.

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The strength of the USD against the Canadian dollar this week and revisiting the DAX

The USD has rallied agains the Canadian this week, helped in some part by the FOMC announcements earlier. Here is a M30 technical chart of the pair.

In the last post I mentioned trading the DAX and using trend envelopes, courtesy of my good friend and a legend of a trader, valeofx from the forex-tsd forum aka Hercs.

As a follow on from that trend which was held in place by the M30 trend envelopes. Here is a chart of today’s action.

As can be seen, the trend envelope on the M30 chart (displayed – Mauve line) and its accompanying 21EMA set to high/low/close acted as strong support for a continued rally, which was firmly corrected, possibly due to DAX December options expiry being today.

Today, the price reached and exceed the resistance 1 pivot level (R1), but closed just above it, before a 50+ point sell off. I favour further bullish activity today, since there is a failed hammer reversal (3rd bar in from the right) and indeed the failure shows a 1 bar reversal (2nd bar in from the right has a lower low, but a higher close than the hammer candle). I’m not holding out, but I think it will go up some more before the close of day. NB. This is educated guessing and not investment advice.

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Quadrant study of the USD Index – is it consolidating lower?

Looking at the USD index, it does appear to be consolidating, having said that, there has been strong USD buying of late. If we take the view that USD index is consolidating (correcting, going down) this means that the dollar will be making losses against Euro, Japanese yen, Pound, Swiss Franc, Aussie and Canadian dollar. My view is that if gains have already been made in any two of these currencies, but especially Euro and one other, gains which look like they are not likely to go much further, but the index is showing a clear pattern, it might be a sign to, in this case, sell the dollar against one of the other currencies, especially if that currency has been strong recently, for example, buy GBPUSD.

In other words, index seems to be going down, indicating short term dollar weakness (intraday). Euro and Japanese yen have already made gains against the dollar. These could continue to lead the index lower, but in case they seem to be stalling, or reversing, it might be worth looking for a reversal in the other pairs making up larger components of the index, particularly if those pairs have been posting losses against the dollar.

Here is the dollar index. Based on the post about quadrant trading the dollar index seems to be moving from the first sell quadrants (4 and 3) into the second sell quadrant (2). Could the index reach the bottom of quadrant (2)? It does not seem an unreasonable thought, especially given the confluence with the 61.8% fiboacci expansion.

The overall message here, is that the idea formed for the day on this basis, is that the dollar is in a weak (consolidation) position today.

It has made a new low, the SMA5 is turning down, the momentum of the SMA8 is slowing and there is a ‘double doji’ pattern (see the orange and pink triangles) which according to this very useful and thorough economics and trading blog post can be a warning of serious consolidation (sometimes).

 

To the upside, the two moving averages will act as resistance. To the downside, the selling of the USD is against the long term trend (turquoise line and purple lines).

In conclusion, the dollar index is a useful way to gauge the currency basket making up the index against the dollar. The immediate implication of the trend is weakness in those currencies against the US dollar (in an uptrend which we have clearly been in for months).

In the short term, there may be opportunities to sell the dollar down against other currencies.

 

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Technical Studies on the DAX unlikely to be found anywhere else

Without doubt my chart and trade of the day is this entry marked on the 15 minute chart on the DAX.

The indicators

  • Pivot points are shown.The MR1 line (red dashed) R1 line (red solid), MR2, R2, MR3, R3 are the only pivots that can be seen.
  • The ‘channels’ are in fact an interesting combination of exponential moving averages
    • A 21 exponential moving average set to close the white dotted line
    • Above and below the exponential 21 MA set to high and low, respectively
      • Notice how when a candle has closed ABOVE the 21EMA(HIGH) the 21EMA(LOW) changes to the MAUVE solid line
      • Notice how when a candle has closed BELOW the 21EMA(LOW) the 21EMA(HIGH) changes to the MAUVE solid line
        • In my trading circle we call this a ‘Trend Envelope’
    • The exact same ‘trend envelope’ setup is transposed from the 30 minute chart onto this 15 minute chart – but it could be set up by flicking between the two charts (colour orange)
    • A 55 EMA is in grey (solid)

Ignore the CCI panel for now.

You will see a fast moving relative strength index (RSI) indicator on the indicator window on bottom.

The analysis

(i) Note how well the M30 trend envelope has ‘held’ – acting as support

(ii) Coming down through the mauve trend envelope (left side of graph), price has bounced off the M30 trend envelope – this is the clue.

(iii) Bouncing off the orange trend envelope, we see 3 bullish black candles, which form a ‘3 bar reversal’ – the third bullish candle takes out the 3 preceding highs.

(iv) The 3rd candle is strong and bullish, and also the 55EMA is turning up and seems to be holding

(v) The RSI7 has moved through the 50 line

(vi) The green dashed line marks my entry, but one could have waited for the break of the M15 trend envelopes for confirmation.

(vii) A beautiful upmove ensues.

That’s all for now.

Have a terrific Friday,

Sam.

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FOMC Projections & An interesting day for cable today.

Review of price action from a technical perspective with fundamental notes

I’ve noticed in intraday trade, the GBPUSD currency pair has been trading a trending move intraday, and almost invariably giving back more than 100% of that move in a given day. So the market might move up 40 pips in the morning, but by midday have gone down 60 pips. Or it might move down 35 pips in the  morning, only to go up 100 pips during the (UK) afternoon.

Today I captured the market behaviour with some technical studies, using a four hourly candlestick chart and a one hourly candlestick chart, some trendlines, which we will be calling a ‘quadrant’ and some moving average indicators.

Without referring to the news yet, I just want to look today at the price action and where it took the pound.

Figure 1, the 1 hour (H1) chart shows the price going up steadly, but in waves and correcting down to the bottom (dark) trendline, from the top (dark trendline).

The exchange rate has clearly ‘bounced’ off the bottom dark line, indicating a resumption of the upmove, if we take only this chart into account.

Figure 1 – H1 chart this morning

First, I noticed how strongly this channel bounced during the morning. This is a one hour chart.

If we broke it down to a half hour chart, we would see a ‘3 bar reversal’ for sure – that is that the newly formed candle has penetrated the highest high of the last three consequetively downmoving candles, a powerful reversal pattern.

If we imagine the trend channel divided further into 4 channels (rather than 2), by adding two more parallel lines at the half way point between the midline and the top and bottom of the channel, and from the top we label the ‘spaces’ quadrant 1, 2, 3 and 4, it is not hard to see that the price has entered into quadrant 3, from quadrant 4.

I have approximated these quadrants in figure 2, below.

Jimmy Young who runs a live trade room and daily trade review and ideas service, has previously taught that entering into quadrant 3 from quadrant 4, is effectively entering the ‘buyzone’. Likewise, coming down into quadrant 2 from quadrant 1, is effectively coming into the ‘sell zone’.

This makes sense intuitively, because if you imagine that the price is trading within these channels and are going from one channel to another in waves, a strong move from the bottom or top channel towards the middle is likely to be followed through from quadrant 2 into 3 (and perhaps down to the bottom of 4) or from quadrant 4 up to quadrant 3, and onwards and upwards into 2 (and perhaps to the top of 1).

Look at what happened by later on in the day…again this is in the H1 chart – I have redrawn in the trend channels roughly, including the two aforementioned lines. Now quadrants 1,2,3 and 4 can be seen clearly.

You can see that the market price for spot pound/dollar kept rising, up through quadrant 2 and then stalled about half way into quadrant 3. The price then collapsed (during an important set of (hawkish presumably) Federal Reserve announcements.

Figure 2 H1 chart by this evening

Could we have moderated for over-aggression using this H1 chart, and thereby been cautious about trying to reach the top of quadrants 3 or 4 in the long play on the H1?

The answer is yes, by considering the higher timeframe. In this case let’s look to the H4 chart.

NB. Jimmy Young taught this analysis method on the H4 chart – a first reason to be cautious of quadrant trading too expectantly on the H1 chart.

As can be seen, the trend and channel direction (slope) does not match that of the H1 chart displayed.

Although the overall trend seems to be up – and therefore, we would expect therefore that GBPUSD could continue to correct upwards (i.e. correcting mid-long term from the Brexit collapse move earlier this year) on this basis, on the H4 chart, we are clearly in a pattern right now of consolidation – of lower highs being posted, and lower lows. Again, the trend channel bears this out.

Over longer time periods, the trend is upwards on both charts according to moving average indicators, which perhaps gave the H1 some impetus for a bit of a run up the channel. The moving averages on the charts (figure 2 and 3) speak for the direction of the trend – apart from the short term average (blue), the dotted line, turquoise line, purple line and pink line in figure 3 are all travelling in an upward direction, although the turquoise has starte losing a bit of momentum (angle is getting weaker).

We have bounced off the top trend channel and are therefore heading DOWN in terms of the trend channel / quadrant though. Note how this is not confluent with what the H1 chart tells us. The longer term chart needs to steer the view in this instance, unless there is a clear ‘failure’ of the channel to the upside.

That blue line is key also. It is an 8 period moving average, and sets the near term trend and has started travelling down. This and the bounce off the trend channel, plus the fact that we are in quadrant 3 and heading down from quadrant 4 all serve as ‘connected dots’ to suggest that the GBPUSD pair is probably still consolidating.

Figure 3 H4 chart this morning

Figure 4 shows what happened during the news – FOMC economic projections and so on.

If you are interested in reading the statement, here is the 14 December FOMC statement

Clearly, the message was hawkish (i.e. suggestive of strength in the US economy, thus the dollar, and possibly hinting at an interest rate hike, or clearly, as we will can see by the big red candle, indicating selling of the pound and buying of the US dollar, market participants got that sense of hawkishness and the big players and intraday winners will have traded it).

What was happening on the H4 was a different story to H1, and a more powerful one…

As you can see, that little move into quadrant 3 in the H1 chart, in fact took the market right to the top of the H4 channel, from which a reversal candlestick pattern (shooting star / hammer type) can clearly be seen followed by the sell off right the way through quadrant 4, 3 and 2 and finally into quadrant 1.

But as if to catch unwary traders out, not without a test of the very high of the hammer candle (+1 pip for those who will have been disappointed today by having a terribly tight stop).

Figure 4 H4 chart by this evening

What to perhaps take from all this in terms of technical analysis and possible strategy.

Learning & Strategy (for educational and not advisory purposes).

  1. Check the H1 and H4 for the channel in which the prices appears to be trending currently. Look for confluence, otherwise the H4 should take precedence.
  2. Quadrant trade short: Sell a move from 4–>3 down to 2 or 1.
  3. Quadrant trade long: Buy a move from 1–>2 up to 3 or 4.
  4. Look for a reversal at the top of bottom of a channel.
  5. Hint: For the hammer reversal candle (the candle before the big downmove), rather than entering on the close with a stop just above the candle, wait patiently for a retrace to 40%, 50% or 60% of the hammer candle as a ‘pre-empt’ of the short, giving some room for stops that are too close to the high of the hammer to be hit, e.g. 12 pips above the hammer high.
  6. Entering at the 50% retrace of the hammer at 1.2710 with a 20-30 pip stop (1.2730 or 1.2740) would have allowed a 30, 60, 90, 120 or even 150 pip profit today.
  7. Short term averages like the 8 period simple moving average can give a clue as to the near term trend. Longer term averages, like the 100 and 200 can give an idea of the medium to long term trends.
  8. There was big news today for the dollar. Trading without a stop somewhere (a decent distance depending on risk willingness for the trade, but undoubtedly above the quadrant 1) could have led to a nightmare had the news gone the other way.

I trust this brilliant and yet simple analytical tool taught to me by a long term bank trader of GBPUSD, Jimmy Young, helps traders make more intuitive sense of the trending nature of markets.

Happy Advent Season,

Sam

 

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