Forex Strategies for High and Low Volatility Markets_2 docx

sellers—price fluctuates, sometimes greatly, from one day to the next. Technical analysis can provide a concise picture of those fluctuations and tell us who is controlling a market currently: the buyers or the sellers. The biggest advantage technical analy- sis has over fundamental analysis is that it takes much of the subjective nature out of the decision-making process. As technicians we don’t care about price outcome; that means we don’t care if the market moves up or down. We are interested only in going where the market wants to take us. There is no opinion for us, no right or wrong price direction. We know it is unreasonable to think we can predict what will happen tomor- row, and so we always avoid getting attached to one outcome over another. We do not predict which way a market will move; we position ourselves to follow along with the market. One of the first things the old-timers told us on the exchange floors was to “lose your opinion, not your money.” Their point was that if you stay attached to your opinions and make deci- sions on that basis and on the emotions behind them, you’ll probably lose money. That saying is one of the cornerstones of what we are going to teach you. In analyzing markets, there are many choices in the tools we use, and choosing a chart is no different. In the charting package I use, seven different kinds of charts are listed. We will discuss the three most common ones now: line charts, bar charts, and candlestick charts. Line Charts Line charts show only the market’s closing price and can be ben- eficial in that they smooth out the price action, making a trend or Mastering the Currency Market 52 direction easier to discern. Figure 3-1 shows a monthly line chart for EURUSD. The line chart is the most simple type of chart and can keep traders from overreacting to price extremes on a short-term basis. It also can make it easier to identify significant support and resistance levels and chart patterns, both of which we will be studying extensively in this book. Bar Charts Figure 3-2 shows a price bar from a bar chart. Bar charts show a market’s open, high, low, and close on a vertical bar and therefore provide more information than does a line chart. On the left side of the bar a horizontal tab indicates the opening price for the time period, and on the right side a horizontal tab Charts for Trading 53 Figure 3-1 Line Chart Mastering the Currency Market 54 Figure 3-2 Price Bar Figure 3-3 Monthly Bar Chart indicates the closing price. The height of the bar represents the entire range of trading within that time frame; hence, it pro- vides the high and the low. Traditionally, bar charts were indicated in black and white, but newer programs use color designations such as green and red to indicate upward and downward movements in price. Figure 3-3 shows a monthly bar chart. In most charting packages the bars will be colored, with green bars indicating the months that closed higher than the previous month’s close and red bars marking months that closed lower than the previous month’s close. In Figure 3-3, notice the pattern of higher highs and higher lows before and then again after the price correction in 2005. This price behav- ior or pattern is characteristic of a bull market. Candlestick Charts Candlestick charts display basically the same information as bar charts but in a somewhat different way. Figure 3-4 shows that the “body” of the candle represents the difference between the open and the close. If the body is white (or green), the mar- ket moved up and the open is represented by the bottom edge. If the body is black (or red), the market moved down and the open is represented by the top edge. The shadows, which also are called wicks, are the lines above and below the candle body and represent the high and low of the time period. Figure 3-4 shows candles in black for a down candle and in white for an up candle. Charts for Trading 55 Bar Charts versus Candlestick Charts Of the two chart types, many would argue that candlestick charts are the preferred type for trading. They give similar information when one is looking at a single time period, but more important, they visually signal other clues about the mar- ket when one is viewing a larger time frame. There are impor- tant things to note about the differences between bar charts and candlestick charts (see Figure 3-5): • The color of the bar on the chart depends on the closing price of the previous bar. If the closing price of the current bar is higher than the closing price of the previous bar, the bar will be green (or white). • The color of the candlestick depends only on the position of the close relative to the open for that time period. Mastering the Currency Market 56 Figure 3-4 Individual Candlesticks • If the market closes higher than it opened, the candle will be green (or white). • It’s usually easier for beginners to work with candlestick charts. • Candlesticks also provide the additional visual signals of trend shifts. For examples of both types of charts in color go to www.Trading-U.com. Candlestick Shapes: Body Size One way candlesticks provide information about market behav- ior is through the length of the candle body. Figure 3-6 shows can- dles with long and short bodies. Long bodies indicate strong price movement, and short bodies tend to indicate indecision. Charts for Trading 57 Figure 3-5 Difference between a Candlestick and a Price Bar Mastering the Currency Market 58 Figure 3-6 Different-Sized Candle Bodies Provide Information about Price Behavior Figure 3-7 Long Shadows Yield Further Insight into Price Behavior Another way candlesticks provide information about mar- ket behavior is through the length of the shadows or wicks. Long shadows represent a failed attempt to move a market in that direction (see Figure 3-7). Candlestick Shapes: Doji The doji (Figure 3-8) represents indecision regarding price and frequently occurs near market highs or market lows. It is char- acterized by a body that is very small and usually has long wicks. We will talk more later in this chapter about how to use the doji as a signal of a change in market direction. Charts for Trading 59 Long-Legged Doji Dragony Doji Gravestone Doji Figure 3-8 Different Types of Dojis Figure 3-9 Spinning Tops Are Similar to Dojis Candlestick Shapes: Spinning Tops Spinning tops (Figure 3-9) are similar to dojis in that they have short bodies and long wicks, with both indicating indecision in the market. They can occur at market tops or bottoms, but they also can show up in sideways-moving markets and dur- ing periods of low volume. Bullish Candle Formations Some of the most useful information can be gained from can- dlesticks when they signal a change of direction in the market. Figure 3-10 shows six common formations that may indicate that the market is headed upward. Mastering the Currency Market 60 Figure 3-10 Potentially Bullish Candle Patterns Bearish Candle Formations Figure 3-11 shows potentially bearish candlestick patterns. Figure 3-12 shows a daily EURUSD candlestick chart. An important aspect of price charts, whether bar charts, can- dlestick charts, or line charts, is that they provide a historical per- spective on a market’s previous behavior. We can’t overstress the importance of having enough information or time on your charts when you are analyzing a market that you potentially will trade. If you were going to hire a person to work closely with you, you would want to know more about that person than what her last job was. You would want an accurate picture of her entire work history before you made that commitment. You probably would not want to waste time asking questions to see Charts for Trading 61 Engulfing Pattern Evening Star Harami Hanging ManShooting StarDark Cloud Cover Figure 3-11 Potentially Bearish Candlestick Patterns [...]... the closing price and there is a very small body; these candles indicate market indecision Change-of-direction candles tend to reverse the previous pattern or direction of the highs and lows If the preceding candles were moving higher, a change-of-direction candle would be a candle in which the close was lower than the low of the preceding candle or candles Similarly, if the previous candles had developed... green (white) candle’s body surrounds or engulfs and then closes above the previous candle’s red (black) body A bearish engulfing pattern occurs when a red (black) candle’s body surrounds or engulfs and then closes below the previous candle’s green (white) body It is this close above the previous candle’s high or below the previous candle’s low that makes engulfing candles change-of-direction candles In Figure... candles had developed a pattern of lower lows, lower highs, or lower closes, a change-of-direction candle would be a candle that closed above the high of the previous candle or candles Figure 4-5 is a daily chart of the British pound from January 20, 2007 that exhibits its share of both dojis and change-of-direction candles You will learn in Chapter 9 that change-of-direction candles are used as trade signals... mid-August Figure 4-12 shows a 15-minute USDJPY chart in which a bearish change-of-direction candle an hour after the London open sets the day’s tone with an obvious pattern of lower lows 79 Mastering the Currency Market Figure 4-12 Bearish Change-of-Direction Candles Followed by Lower Highs and Lows and lower highs, followed by a second bearish change-of-direction an hour after the U.S open that accelerates... individual candles establishes and reinforces the direction for the trends on the charts for all time frames It is often said in this business that one day does not make a trend, but one candle can shift a trend, another can reinforce that shift, and a third can confirm that shift The study of individual candles and candlestick formations in all time frames is an important aspect of trading and is well... doji, followed by a change-of-direction candle before an up move The inside candle is telling us that the market lacks conviction in regard to its direction The inside candle is considered pivotal in that the market is expected to increase momentum in whichever direction it closes in relation to the high and low of the inside candle A close above the high of the inside candle is considered bullish, and. .. Support and Resistance T he next aspect of charting a trader needs to understand is support and resistance Markets generally move up and down in a somewhat irregular manner and rarely reach the point to which they are heading in a straight line A bull market moves up and then generally pulls back slightly and finds support before continuing to climb higher A bear market moves lower and then pauses and tries... topping candle, afterward, followed by a sell-off through the London 78 C a n d l e s t i c k C h a rt s Figure 4-11 Collective Candle Behavior before Market Reversal session and the U.S a.m session Just ahead of lunch on July 11, which is a Friday, we see a hammer and then an inside bar, followed two candles later by a sharp change-ofdirection candle higher ahead of the weekend as longer-term, higher... price behavior came on support or resistance For forex markets, we discount candles and formations during low- volume, low- trade periods such as from lunchtime in New York to the Tokyo open, and we do not make any analytic or trading decisions until the candle is closed You will find that knowing that you do not have to make a trading decision until the candle closes will keep you relaxed, as you know... bullish, and a close below the low of that candle is considered bearish When you are viewing intraday forex charts, keep in mind that low- volume candles such as those between 17:00 and midnight Greenwich Mean Time (GMT) should be discounted, as their behavior is not considered nearly as significant as that of candles on higher volume The hammer, which is also a doji, is considered a bullish candle A hammer . close was lower than the low of the preceding candle or candles. Similarly, if the previous candles had developed a pattern of lower lows, lower highs, or lower closes, a change-of-direction candle. 3-4 shows candles in black for a down candle and in white for an up candle. Charts for Trading 55 Bar Charts versus Candlestick Charts Of the two chart types, many would argue that candlestick charts. closed higher than the previous month’s close and red bars marking months that closed lower than the previous month’s close. In Figure 3-3, notice the pattern of higher highs and higher lows before