P1: OTA c11 JWBT185-Horner October 24, 2009 19:41 Printer: Yet to come Trading Edge 139 If you have tried using chart patterns in the past, you may have had hit or miss luck with them. That’s mainly the reason why anyone discards anything. It doesn’t work. The remainder of the reason lies in a basic human trait: the search for something better. This unknown may exist on some levels of living, but not in trading. What’s best for you may not be best for me. “Best” is relative. Remember a couple basic ideas of price: 1. News and fundamentals are built into price action. 2. Price action reflects the psychology (think: fear and greed) of the market. I am not a technician (technicians rely more on indicators, which are always lagging), but rather I am a chartist who focuses on price. Nothing leads price. Some tools like pivot points and Fibonacci levels may forecast, but this is not predicting. The other aspect of price that no one seems to tell anyone—so I’m going to tell you now—is that price can only be interpreted effectively if the underlying market direction is identified. It was reading article after article written by Charles Dow that crystallized this for me. The market currently is in one of four market cycles: accumulation, mark up, distribution, mark down. A market, you have learned, can only travel up, down, or sideways. This is not enough, though. We must know how to identify the current cycle in real time. Now take this concept back to what may have been a hit or miss re- lationship with chart pattern–based entries. Occasionally, I can imagine, they worked, and occasionally they did not. In all likelihood you were by chance pairing trending patterns with a trending market and sideways pat- terns with sideways markets. Eventually the frustration of this haphazard winning and losing made you drop chart patterns and move on. They’re for newbies after all, you may have huffed as you went to Google to search out your next trading strategy. So what do we know now? Chart patterns must be paired with the correct market cycle. Here’s how you can use a simple trio of three Fibonacci–based moving averages to accomplish this. I call it the “Wave,” as you now know. The Wave, to recap, is three 34-period exponential mov- ing averages, one set on the high, one set on the close, and one set on the low. These lines will travel up, down, and sideways across your charts. When they are used in the proper reference, you will have what I call a clock angle. For example, if you are trading off a daily chart (also known as an “end of day” chart), ideally you should be looking at a year’s worth of data. This amount of data does a few things for you. First, it will put P1: OTA c11 JWBT185-Horner October 24, 2009 19:41 Printer: Yet to come 140 FOREX ON FIVE HOURS A WEEK all relevant price action front and center: recent trends, 52-week highs and lows, and reversals. Second, it will allow you to take a proper clock angle reading, which means that the year’s worth of data compresses price action into the right scale so that when you look at the angle of the three lines, it’s an accurate reading of the cycle the market is currently in. Let me mention right now that while I will be using chart patterns, there is not a trader alive who couldn’t benefit from an accurate and real- time reading of the current cycle of the market. It’s not limited to any style of trading. In fact, it’s the very reason you should be utilizing one type of entry over another. All entry styles currently are designed for trending, re- versal, breakout/breakdown, or range-bound cycles—whether you know it or not! So the first thing you must determine about your current stable of entry strategies is what cycle was it meant to capitalize on. No single entry strategy can capitalize on every cycle. That’s a fact. When it comes to trending versus nontrending patterns, it’s fairly easy to determine this with the chart pattern name. Falling wedges and down channels are, as their name implies, downtrending patterns. Rising wedges and up channels are uptrending patterns. I mention this because many times traders find the lines and levels that form a pattern and then go straight to entering a trade based upon those boundaries. The problem with that is the missing step. In order to use a trending chart pattern set-up cor- rectly, the underlying market must be in a trend. Except for the Wave, I know of no other way to do this in real time. As shown in Figure 11.1, the 15-minute USD/CAD is heading down at what I would call a four to six o’clock angle. This is also a mark down or downtrend. The downtrend would be a perfect pairing for a downtrend chart pattern like a falling wedge or down channel: not however for a tri- angle, rectangle, double or triple top or bottom, as these are examples of sideways or range-bound patterns better suited to an accumulation or dis- tribution cycle. See Figure 11.2. This is not limited to short-term intraday chart analysis. How about a longer-term, end-of-day chart of the EUR/USD? See Figure 11.3. As shown in Figure 11.4, this is a down channel and must be traded in a downtrending market. So finding the pattern is step one. Confirm- ing that this pattern is occurring in the correct market cycle is step two. Now realize that chart patterns are simply the combination of downtrend lines, uptrend lines, horizontal support, and resistance. This channel is two downtrend lines. Has it formed in a mark down cycle? Use the clock angle of the Wave to determine. This market cycle filter or confirmation step can be applied to any type of trading as long as you know which market cycle your strategy was de- signed for. This is something that most traders don’t consider, mainly be- cause they are seldom told to. Traders usually define themselves by their P1: OTA c11 JWBT185-Horner October 24, 2009 19:41 Printer: Yet to come Trading Edge 141 1.1600 1.1550 1.1500 1.1450 1.1400 1.1350 1.1300 1.1250 1.1233 1.1188 04:00 05/20/09 05/21/09 05/22/09 (CAD A0-FX - CANADIAN DOLLAR,15) Dynamic,0:00-0:00 09:00 14:00 19:00 00:00 05:00 10:00 15:00 20:00 01:00 06:00 11:00 16:00 1 . 1223 1 . 1213 1.1200 FIGURE 11.1 Confirmed Downtrend with the Four to Six O’clock Wave Angle © eSignal, 2009. 1.1600 1.1550 1.1500 1.1450 1.1400 1.1350 1.1300 1.1250 1.1233 1.1188 04:00 05/20/09 05/21/09 05/22/09 (CAD A0-FX - CANADIAN DOLLAR,15) Dynamic,0:00-0:00 09:00 14:00 19:00 00:00 05:00 10:00 15:00 20:00 01:00 06:00 11:00 16:00 1 . 1223 1 . 1213 1.1200 FIGURE 11.2 The Falling Wedge Pattern Should Only Be Traded in a Downtrend © eSignal, 2009. P1: OTA c11 JWBT185-Horner October 24, 2009 19:41 Printer: Yet to come 142 FOREX ON FIVE HOURS A WEEK 1.6000 1.5500 1.5000 1.4509 1.4364 1.4000 1.3632 1.3500 11 18 25 03 10 17 24 31 07 14 21 28 05 12 19 26 02 09 16 23 30 07 14 21 28 04 11 18 25 01 08 15 22 29 06 Mar Apr May Jun Jul Aug Sep Oct (EUR A0-FX - EURO,D) Dynamic,0:00-24:00 MA(34,H)e MA(34,C)e MA(34,L)e 1 . 4275 FIGURE 11.3 Two Parallel Downtrend Lines Form a Down Channel © eSignal, 2009. 1.6000 1.5500 1.5000 1.4509 1.4364 1.4000 1.3632 1.3500 11 18 25 03 10 17 24 31 07 14 21 28 05 12 19 26 02 09 16 23 30 07 14 21 28 04 11 18 25 01 08 15 22 29 06 Mar Apr May Jun Jul Aug Sep Oct (EUR A0-FX - EURO,D) Dynamic,0:00-24:00 MA(34,H)e MA(34,C)e MA(34,L)e 1 . 4275 FIGURE 11.4 The Down Channel Is Only Valid in a Downtrend © eSignal, 2009. P1: OTA c11 JWBT185-Horner October 24, 2009 19:41 Printer: Yet to come Trading Edge 143 2.1000 2.0500 2.0000 1.9892 1.9711 1.9571 1.9319 1.9000 1.8500 15 22 29 05 12 19 26 02 09 16 23 02 09 16 23 2009 Feb Mar (EUR/AUD A0-FX - EURO/AUSTRALIA DOLLAR COMPOSITE,D) Dynamic,0:00-24:00 MA(34,H)e MA(34,C)e MA(34,L)e 1 . 9500 FIGURE 11.5 Rectangles Are Consolidation Patterns © eSignal, 2009. trading entry style: “I’m a swing trader” or “I’m a momentum trader.” This is only half true. When the market cycle is sideways, only then should you be a momentum trader. When the market is trending, you should look for swing entries and trending patterns. Let the cycle dictate your entry! Let’s look at a sideways pattern. This one is an interesting look at what could be one of two choices. A few things to take note of: Do you see the width of the pattern? The range from the horizontal resistance to the horizontal support is wide enough to merit trading within the range. See Figure 11.5. Inside the range trading is a strategy that takes advantage of wide side- ways patterns like this, with static (horizontal) levels that can be shorted at the ceiling and bought at the floor. Alternatively, a breakout/breakdown play can be set-up that would entail waiting for price breaking up through the ceiling or down through the floor. Of course, this pattern must be con- firmed by a sideways market cycle. See Figure 11.6. In each of these examples, the chart pattern was only considered a potential entry after the market cycle confirmed that the pattern was oc- curring in the appropriate cycle. Without this confirmation, the lines and levels of the pattern could potentially be acted upon incorrectly. No mat- ter what your trading style, understanding which cycle your strategies are most likely to succeed in will increase the chances that you’ll be on the right side of price action. See Figures 11.7 and 11.8. P1: OTA c11 JWBT185-Horner October 24, 2009 19:41 Printer: Yet to come 144 FOREX ON FIVE HOURS A WEEK 2.1000 1.9892 1.9711 1.9319 1.9000 1.8000 1.7000 1.6000 24 07 21 05 19 02 16 30 14 28 11 25 08 22 06 20 03 17 01 15 29 12 26 09 23 09 23 MarFebDecNovOctSepAugJulJunMayApr 2009 (EUR/AUD A0-FX - EURO/AUSTRALIA DOLLAR COMPOSITE,D) Dynamic,0:00-24:00 MA(34,H)e MA(34,C)e MA(34,L)e 1 . 9511 2 0000 FIGURE 11.6 The Wave Indicates a Sideways Market on the Daily EUR/AUD © eSignal, 2009. 12/10/2008 09/11/2008 FOREX:EUR/AUD (Daily) - Continuation Rectangle 07/12/2008 04/01/2009 01/02/2009 1.7686 1.8186 1.8686 1.9186 1.9686 2.0186 2.0686 2.2186 FIGURE 11.7 Chart Pattern Identification Automated by Autochartist Software Images © Autochartist. P1: OTA c11 JWBT185-Horner October 24, 2009 19:41 Printer: Yet to come Trading Edge 145 2.1000 1.9995 1.9622 1.9000 1.8000 1.7000 18 25 01 08 15 22 29 06 13 20 27 03 10 17 24 01 08 15 22 29 05 12 19 26 02 FebDecNovOctSep 2009 (EUR/AUD A0-FX - EURO/AUSTRALIA DOLLAR COMPOSITE,D) Dynamic,0:00-24:00 GRaB FIGURE 11.8 Confirm the Rectangle with a Sideways Wave © eSignal, 2009. THE RIGHT SIDE OF THE CHART As traders, the only reason we need to know what has happened (the left side of the chart) is to determine what will happen, and that’s the right side of the chart. Too often we get caught up in discussions of why some- thing happened. But when it is not balanced out with a discussion of how this will help us figure out what will happen, it’s simply a mental exer- cise and not trading. I see plenty of cocktail party analysis on the Web. I strive to join their party because even if I go off on some fundamentals- based discussion of the market I hope my better angels will bring me back to what is actionable about it. Actionable analysis is something that is not commonly found. Actionable analysis is about telling the reader what you think will happen, how, and why. It takes guts to be specific about set-ups and price. That’s what it means to focus on the right side of the chart. Cocktail party analysis is almost always either very long term (at least a one- to two-year time horizon) or refers to the left side of the chart. Fun- damentals are almost always left side because data is backwards-looking. There is no piece of data—Non Farm Payroll, Unemployment, Retail Sales, Gross Domestic Product—nothing, that will lead the charts. If you know of a fundamental that is bullish in nature, you can be assured that it is not the only one—not that there isn’t a bearish piece of data out there, too. The trick is to understand what is actively being discounted at the moment. P1: OTA c11 JWBT185-Horner October 24, 2009 19:41 Printer: Yet to come 146 FOREX ON FIVE HOURS A WEEK There are certain relationships that the market will look at. The Dow and USD/JPY is one such relationship. CONSUMER CONFIDENCE Has all the negativity of the stimulus plan been reacted to? Has it— at this point in the media and public— been fully discounted into price? It can be agreed that we’re going to spend over a trillion dollars of tax- payer money and we’re going to do something versus nothing. There are two things that can be of benefit and that is to not do more damage to the economy and inject optimism via capital into the economy, but more specifically, the U.S. consumer. If consumers think the economy is turn- ing around, they will buy, and that’s what’s going to improve the econ- omy. Not better data. Data is lagging. Consumer psychology will be lead- ing. Because of this, the consumer will feel better before the data looks better. I was speaking to a friend of mine who works for a fund and decided that in an “alternate universe” Treasury Secretary Timothy F. Geithner an- nounced every last detail of the plan and the equities market sold off all the same. The reason is that Wall Street ran the market up (discounted the an- nouncement) and the only surprise would have been (1) no announcement or (2) that the United States won some intergalactic lottery and thus paid off the debt. In other words, no matter what, the equities markets were going to sell off. I mention all this because it has a direct effect on the USD/JPY. Is the current price action the beginning of a sideways/bottoming cycle? Let’s dis- sect the daily chart. Starting with the green, red, and blue or GRaB charts, there is confirmation of the sideways cycle transition on the daily with the 34 EMA Wave indicator moving sideways, indicating a transition to an ac- cumulation or distribution market cycle. See Figure 11.9. Currently the Fibonacci levels on the daily USD/JPY showcase a solid double bottom at 87.10 to 87.12, which can at very least establish a short term floor. The ceilings are identified by the 25 percent, 38.2 percent, and 50 percent Fibonacci retracement levels. See Figure 11.10. One floor and multiple ceilings could contain both further upside and downside on the USD/JPY as there are significant arguments that the negativity in the Dow has been fully discounted. If the 87.10 to 92.25/93.83 area is going to be in the consolidation range going forward, then that indi- cates that the Dow will consolidate here as well. P1: OTA c11 JWBT185-Horner October 24, 2009 19:41 Printer: Yet to come Trading Edge 147 3 Feb 2008 18 Apr 2008 3 Jul 2008 16 Sep 2008 110.50 107.10 103.70 100.30 96.90 93.50 90.33 86.70 USD/JPY,Daily 90.43 90.75 89.69 90.33 FIGURE 11.9 A Transitional Market Cycle on the Daily USD/JPY 13 Nov 2008 2 Dec 2008 21 Dec 2008 27 Jan 2009 8 Jan 2009 98.15 78.6@97.67 61.8@95.41 50.0@93.83 38.2@92.25 25.0@90.48 0.0@87.12 96.55 94.95 93.35 91.70 90.35 86.90 88.50 USD/JPY,Daily 90.43 90.75 89.69 90.35 FIGURE 11.10 Fibonacci Identifies Potential Floors and Ceilings on the Daily USD/JPY P1: OTA c11 JWBT185-Horner October 24, 2009 19:41 Printer: Yet to come 148 FOREX ON FIVE HOURS A WEEK /10/2008 07/11/2008 02/12/2008 26/12/2008 20/01/2009 12/02/2009 103.33 102.33 101.33 100.33 99.33 98.33 97.33 96.33 95.33 94.33 93.33 92.33 91.33 90.33 89.33 88.33 87.33 FIGURE 11.11 An Autochartist Symmetrial Triangle on the Daily USD/JPY Images © Autochartist. RISK APPETITE The USD/JPY is approximately six days into a market cycle shift into ac- cumulation. There is now a chart pattern alert to reinforce this shift, and while it may not immediately usher in a return of risk appetite, investors’ stomachs are beginning to growl. See Figure 11.11. The trendline to keep an eye on is the downtrend line (the green resis- tance line) on the asymmetrical triangle pattern. This congestion pattern is currently trading near the downtrend line with the breakout level just below the 92.00 major psychological level at 91.84. See Figure 11.12. The bias for a breakout can be tempered with the fact that the Dow is still below 8,000 but, focus on the signals from the daily USD/JPY. There are reasons to look for higher highs, but the bullish engulfing is one. See Figure 11.13. This all means that there are still ceilings that the USD/JPY must trade up through before the sideways market cycle can transition into proof that risk appetite has returned in equities and that the USD/JPY will trend higher to reflect that. It’s a major shift in investor psychology we’re waiting on now. SELL THE NEWS The Dow is currently down significantly mainly on a “buy the rumor, sell the news” response to the release of the stimulus package on what seems [...]... not a broker, but I have to say that sometimes this question starts to take on a mythology like an X Files conspiracy theory Stops are run in any market where market makers or pit traders or whoever can anticipate a large number of orders sitting at a fairly predictable price level or area It’s like shooting ducks in a barrel not that I have anything against ducks O 153 154 FOREX ON FIVE HOURS A WEEK... comments and suggestion on risk management? What is your position on the rule that many traders have, that at one given point you should not risk more than 1 to 2 percent of your total account value? Is it true that if I have a $10,000 account I should not risk more than $100 to $200 in a trade? And what about placing orders on correlated pairs like the USD/CHF and EUR/USD at the same time if the conditions... because merely being long on one does not justify being short the other in my opinion And from the way the question was phrased, I would say you got that This also brings up a great point, harmony I look for trades, when taking positions across different pairs, to have harmony I don’t want to hedge, and I don’t want to take entries on the same time frame on different pairs that would require, for example,... began consolidating and where the triangle pattern developed As a general rule, the USD/JPY will continue to fall as long as the risk aversion that permeates the equities market continues Furthermore, this lack of risk appetite will continue to make the U.S dollar the world’s safe haven currency The stimulus plan put an exclamation point on the feeling investors have about U.S stocks and their fear... 11.14 An Intraday, 30-Minute Chart of the U.S Dollar Index Futures Contract © eSignal, 2009 to be a calculated lack of specifics from Treasury Secretary Timothy F Geithner for how the plan will be executed The street hates uncertainty more than bad news, and there are plenty of questions, leaving traders rallying the dollar in a continued safe haven play See Figure 11.14 With a dramatically weaker Dow and... psychological than it is technical or fundamental analysis First of all, the decision to enter a trade is based upon some sort of analysis Regardless of what yours is, there was a reason the trade was valid The concept of validity is important because stop losses should not be based on a percent or dollar amount but rather where the trade is no longer valid I had a student who just absolutely could not, would not... if all that work went into the entry, then how come we throw that out the window for some random risk management stop loss? First of all, it stems from the fact that most traders don’t consider validity a risk management strategy It should be the only consideration! Why 158 FOREX ON FIVE HOURS A WEEK would I hold on to a buy beyond the reason I first got into the trade? The reason traders don’t use validity... traders can use to determine what the market cycle is The Wave is what I use, and while I am biased, I do believe a combination of the Wave and market memory is the best way to identify the cycle of the market 160 FOREX ON FIVE HOURS A WEEK Don’t Let a Winner Turn into a Loser: Ratchet Your Stops It’s a trading truism that is seldom accompanied by any insight into how to actually accomplish this balancing... balancing act There is a fine line between giving a trade the wiggle room it needs and moving beyond the reason you took the trade in the first place The reason that most traders do not successfully find this balance is that there needs to be some definition of what trade validity is Usually, the reason to stay in a trade and stop loss placement are based upon some arbitrary figure, typically a percentage or... thought of being wrong is not a comfortable one, and as human beings we will do and say anything to avoid it This includes the conversations we have with ourselves when a trade is going against us It’s a feeling that only traders can share with one another: the self talk, the denial, the bargaining The problem is that this behavior can finally manifest itself as a reason to . will have what I call a clock angle. For example, if you are trading off a daily chart (also known as an “end of day” chart), ideally you should be looking at a year’s worth of data. This amount. better angels will bring me back to what is actionable about it. Actionable analysis is something that is not commonly found. Actionable analysis is about telling the reader what you think will happen,. to come 1 46 FOREX ON FIVE HOURS A WEEK There are certain relationships that the market will look at. The Dow and USD/JPY is one such relationship. CONSUMER CONFIDENCE Has all the negativity of