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All traders should have a daily calendar of pending, scheduled announcements for the currencies they tradeTactics and Strategy Here I present a potpourri of tactical and strategic trading ideas culled from countless years of trading. Screenwriter Lew Hunter claims it is the small touches that make a movie special. It is the same for traders. The small touches you add to your trading program can make it stand out from the crowdand I know the crowd usually loses. They can also add a personal flavor to your trading, giving it a unique style. It may astound you how a small jiggle can change bottom-line performance in a big wayfor better or for worse. Think about your trading program with some perspective; consider the totality of it all, but keep an eye on the details, too. Is it coherent, efficient? Do the various parts work together well, perhaps offer a little the-whole-is-greater-than-the-sum-of-its-parts synergy? Are you pleased and proud of it? Does it have style? Trending and Trading Markets Markets have traditionally been classified as trading markets or trending markets, meaning they move predominantly sideways or predominantly up or down. For an excellent modern look at this conventional approach I recommend Ed Ponsis FOREX Patterns and Possibilities: Strategies for Trending and Range-Bound Markets. While this classification is useful, it is limited and very general. Markets are much more than simply trending or trading. Further, trending and trading are relative. A five-minute chart of the EUR/USD may be trading while an hourly chart may be trending. Market Environments (ME) ME is a method for determining a more meaningful and accurate profile of any market. It is enormously useful as a complement to your trading method, money management, and performance analysis. It can also be used in what is called quant in the industryrisk, portfolio, and money manager analysis. ME also teases out indicator-like information directly off charts without the need for calculation. Bar charts work perfectly. Market Environments was developed by Charles B. Goodman and I have done further development and research. I use it as a primary tool in my Codex approach to trading and include it in my trading method heuristic, money management, and performance evaluations. There are two primary MEs, two secondary MEs, and a single tertiary ME. Just using the two primaries may add meaningfully to your trading arsenal. Directional Movement (DP) and Volatility (V) Directional Movement is the net price change from price-time point A to price-time point B. In Figure 16.2, draw a straight line from the low price at the beginning of the trend to the high price at the end of the trendthe directional movement. This is the net price change. Note that there is price movement on either side of the directional movement line. There are precise methods for measuring DP, but the core concept is simplicity and avoiding the calculations necessary with indicators. Directional Movement = P(rice)2P(rice)1 With A at 0-0 divide the 90 degrees of the chart into five sections. Scale the 90 degrees to equal 100 percent and make each segment 20 percent. Label them 1 through 5. Volatility is the gross price movement from A to B, given a specified minimum price fluctuation value. You may obtain a ratio with V/DP. Look at a sampling of 50 or 100 charts to get an idea of volatility ranges, then divide the samples into five equal segments as with DP. In the conventional classification volatility would be similar to trading. You can plot DP and V either on a 10 10 matrix or use a continuum from 1 to 25: 1 is lowest V and lowest DP; 25 is highest V and highest DP. Every market can be defined as one of these 100 MEs or on a continuum. The secondary MEs are RhythmTime Rhythm and Price Rhythm and Thickness. Price and Time Rhythm (PR and TR) The markets very often have regular price and time rhythm. But you wont see them if you arent looking for them. For time rhythm, measure the length of time (number of time units along the horizontal scale of a bar chart). Measure bottoms to bottoms and tops to tops; make an average of each. The closer the average is to each of the specific instances, the more regular the time rhythm. For price rhythm do the same measurements of up trends and down trends. Keep a running record of both values and again, average them. Thickness (T) Thickness is loosely defined as how much the range from high-to-low of a bar overlaps the previous bar. The more overlap, the thicker the pair or market. Thick markets by definition also possess low volatility and low directional movement. It is enough to define three ranges of thicknessthick, average, and thin. I have found that my trading program works exceptionally well in thick markets. Therefore I seek out such markets to watch on a regular basis. Shape (S) To determine shape, draw a line along the significant tops of the market. You may use the same peaks you used for price rhythm. Draw a line along the significant bottoms of the market; you may use the valleys you used for price rhythm, also. The shape forms a rough channelMr. Goodman called it a semaphore in which prices have moved. Average the widths of the channel from topbottoms. TIP: You may not want to enter a buy side order near the top of the channel average nor enter a sell side order near the bottom of the channel average. Pretzels (PZ) 1) Draw a line between the top of a primary swing and the bottom of a primary swing; 2) draw a line between the top of a secondary swing and the bottom of a secondary swing; 3) draw a line connecting the tops and a line connecting the bottoms. These create pretzels, an offshoot of a charting technique invented by the late, great commodity broker Eugene Hartnagle. Somewhat similar to candlesticks, the pretzels yield much information in the angles of the lines, the shapes of the two triangles, and the relative volume of the two triangles. In a unit price chart, pretzels may be made by connecting the high to the low and the open to the close, crossing the tops and the bottoms. For more on pretzel charting, see the Currency Codex section of www.fxpraxis.com. ME Applications Before initiating a trade, seek to define, even if roughly, directional movement and volatility. What do you see? Do they fit in with the conclusion you reached from the analysis of your other tools? If not, why not? Is it important? Look at the time rhythm and price rhythm. Is the timing of both rhythms good for a trade? If either the time rhythm average or price rhythm average is off substantially, it may be good to take a bit longer look before pulling the trigger. If both are off, perhaps consider passing the trade. If it is still on when the rhythms come into line, then you may have a winner. Is the market thick or thin? A Market Environment Profile is the complete set of MEs for a given chart. Specific currency pairs will sometimes exhibit stable market environment profiles over relatively long periods of time. For each trade you make, keep a short notational record of the directional movement and volatility for that market. Once a month, compare your winning trades with your losing trades. Almost all traders find they do better in some primary MEs than in others. To dig deeper, keep ME profiles for all MEs on your trades, and look for winning patterns and losing patterns. Mutual and hedge funds, which use multiple managers, may use this last idea to allocate funds to specific managers for specific anticipated long-term MEs; managers receiving more money to trade in markets in which they excel, less in markets in which they do poorly. Market environments may also be used to back-test systems and methods using historical data. Rather than look for the usual suspects of Sharpe Ratio and so forth, look for methods that did well in a very wide range of market profiles. The Three Chart System This is a well-known, popular, and effective tool. Each trader profile should use three FOREX charts with different time unit scales for each currency pair they trade. The middle chart is the analysis chart. The largest unit chart is used for perspective. The smallest scale chart is used for timing. Scalper Day Trader Position Trader 1-minute 5-minute 30-minute 6-hour 5-minute 30-minute 1-hour 12-hour 30-minute 1-hour 6-hour 3-day I would not trade without the Three Chart System. The Dagger Entry Principle This is embarrassing in its simplicity but effective. More often than not, simpler is better. The principle first appeared in an article, Conservation with a Gnome, by Michael D. Archer and R. David Van Treuren in Denver Magazine It involves three easy steps: . Identify the major trend within the context of your trading profile. 2. Wait for a significant correction, a secondary trend in the opposite direction of the major trend. A significant correction is typically a minimum of 25 percent. 3. Enter your trade as soon as prices resume moving in the direction of the major trend. The Dagger presupposes you have already identified a trade candidate from your trading program work and are watching for an entry point. Sitting on Your Hands Traders do not particularly enjoy sitting on their hands. It is akin to going to a casino and not throwing a few dollars into a slot machine. The underlying concept is to be patient and wait for trades that really line up for your personal trading programtrading method, attitude, and money management. FOREX provides over 20 highly liquid currency pairs and multiple time frames. The trader is never long without an opportunity. Take your time, pick and choose, then seize the moment! Wait, as Mr. Goodman would say, for the sitting ducks. Be an active watcher; you are sitting on your hands, not covering your eyes. Ask questions, form hypotheses, see how the market reacts, draw conclusions, take notes. Id much rather miss a good trade and not win than roll snake-eyes and lose money unnecessarily. Time Filters The author has done enormous statistical work on time filters. Some of these studies were published in the now out-of-print and privately published Currency Traders Companion series. Below is a brief overview of the subject. Market Opening Officially the FOREX market opens at 5:30 P.M. EST, though different brokers react differently in different time zones. Keep in mind that over the weekend all currency pairs carry an extra premium in transaction cost. A normal 3-pip bid/ask spread during normal trading hours may increase or balloon to a 10-pip or even 20-pip spread on weekends. Once the weekend transaction costs return to normal, many pairs exhibit high volatility due to economic influences that occurred over the weekend. The effects of these influences have pent up while traders have been away. Analyzing a set of a number of currency pairs enhances profit opportunities. Frequently a trend emerges in one direction or the other and continues until the weekend influences have been absorbed by the markets. This may entail tracking several more pairs during the early hours of Monday morning than one would normally follow. When opportunity knocks . . . Market Closing Many corporations like to clear out last-minute orders on Friday afternoon to avoid possible rollover charges and reduce the risk of holding substantial positions over a weekend. Three-day weekends exacerbate this phenomenon. This equates to increased volatility right before the market closes at 4:20 P.M. on Friday afternoon. If you trade during the peak period of volatility, always be certain to liquidate your trades before the bid/ask spread jumps to its increased weekend range. Time of Day For the most part, the higher volatility periods revolve around banking hours in New York City. This overlaps only slightly with banking hours in London and Frankfurt. Another factor is the time zone in which your broker is located. Taking these three factors into consideration plus your own time zone, you should be able to determine periods of high volatility that increase risk and reward. See Appendix F for details on time zones and banking hours. Day of Week The days on which the market opens and closes have already been discussed. Other days of the week may also have special significance. For instance, new interest rates are normally published on Thursdays, which causes immediate changes in USD pairs. Keep your FOREX calendar computer-side and be aware of pending news for the currencies you trade. Trading the News Dont do it! There are many news tradersthose who wait for a news event and try to catch the reaction it invariably entails. I strongly recommend against trading the news for new FOREX participants. Volatility goes into overdrive and although profits can be large and fast, so can losses. Such opportunities do not fit my sitting duck or Belgian Dentist advice for new traders. I have observed a phenomenon I call shockwave or Price Trace Dispersement (PTD). In many instances the initial reaction to news or an announcement will be a short but sharp price move in one direction. Then occurs the shockwave: a price movement in the opposite direction of the initial reaction, significantly longer in both time and price duration. All traders should have a daily calendar of pending, scheduled announcements for the currencies they trade. My advice is not to trade these announcements. In fact, I prefer to be on the sidelines just before the announcement and until the shockwave begins. Watch the markets reaction to the news. Is the reaction as anticipated, or different? Traders sometimes refer to this as expectation. Expectation, if it is different from reality, can tell you a lot about the technical underpinnings of the market at that particular time. Dont be quick to judge the news reaction; the shockwave may last several hours. If you must trade the news, do use an execution tool such as www .forexnewsweapon.com. An invaluable reference is James Bickfords Forex Shockwave Analysis. Going Against the Crowd There are now quantified daily studies of Contrary Opinion in the currency markets. The most convenient is Jay Meislers www.global-view.com weekly poll of professional traders. But it isnt difficult to tell from the news where the public (read retail traders) will be found and on which side of the market they will be trading. The authors www.fxpraxis.com will soon offer a quantified Contrary Opinion tool for FOREX traders. The logic of Contrary Opinion is flawless; gathering the information is the difficult part. Once everyone is bullish or bearish, everyone will inevitably be in the market on that side. Where will the money be to take the new positions to continue to drive that trend? Remember, once buyers buy or sellers sell they have functionally no impact on the market until they offset their position. Trading Methods I was once bounced from an experts forum because of my unconventional ideas about trading methods. In a discussion on support and resistance, I proffered the heretical idea that since so many traders used the same methods to calculate support and resistance, they couldnt possibly be of value. I want to find support and resistance areas that other traders ignore. That is where the money is, in my humble and contrary opinion. This does not mean conventional methods are taboo. It does mean to be aware that many others are using them and have read the same books you have. Conventional chart patterns have been around so long that I find it difficult to believe they can still be the basis of a successful trading program. Those who do use them seem to have found a twist that sets them apart from the crowd. This also is about expectation. If too many traders expect an indicator or chart pattern to work, it wont; it cant. Markets anticipate events. If everyone anticipates prices going to a certain price to form a head-and-shoulders chart formation, prices will never get there. Traders will anticipate that price and begin buying and selling on that expectation well before prices reach that level. Markets also discount information. This means that information finds its way into prices before the event. Buy on the rumor, sell on the news. Stock traders anticipate endless growth from a company. How often have you seen a quarterly report with a large increase in earnings, but the stock price drops? The market anticipated the report, and there is no one left to buy. Worse, while the earnings were good, the rate of earnings was lower than expected. A weekly hour on the FOREX forums over the weekend will give you a good idea of upcoming expectations. Make a note of them, and see how the market actually reacts. I advise against perusing the forums during the week unless you are seeking specific information; it can be too unsettling. The Flyer No, this is not a new trading method. I advise tradersonce they have established some basic stability in the marketsto take the occasional flyer. Yes, I advised you to pick your tools and stick with them. But it is easy to get in a rut. Sometimes we need a self-push to see things from a different perspective, encourage our imagination to find new ideas or joggle the subconscious into freeing an idea or solution tucked deep away. If you are a scalper, try a day trade. If you use GSCS as a primary trading tool, try DiNapoli Levels. Trade a different pair. I traded FOREX eight years and never gave a second glance at the AUS/USD. One night I took a flyer on it. Now, it is one of my favorite markets. Even a different look may encourage something good. Change the scale or colors on one of your charts for a day. Pick an indicator you have never studied from your broker-dealers platform, and add it to a chart for a week. Bathtub Analysis Despite the intensive research of the markets using computers over the past 30 years, I am certain there is much yet to find; new methods, chart formations, tactics, and filters. Mr. Goodman used what he called Bathtub Analysis. It is a form of what scientists call hypothesis testing. The logic is that if you arent looking for something, you wont find it. Take a few dozen charts with you the next time you bathe or have a few moments of quiet solitude. An hour in the den with classical music in the background and two fingers of a good single-malt scotch also works! Form hypothesesmake them as wild and imaginative as you can; be creative. If the market opens higher and closes lower for three consecutive time units, what happens on the fourth unit? Look for patterns. Keep a notebook. There are an infinite number of hypotheses to test. Some complex ones would require a computer, but many would not. If your bathtub analysis turns up something promising, drill down on a few dozen charts, and see if it holds up and/or can be quantified in some fashion. Summary Market Environments may be used as a trading method, a money management tool, and as a performance analysis method. Do not encumber your trading program with dozens of small tactical tricks. Stay focused on your primary tools. But do be open to new and promising ideas, especially those that will complement your program. Seek synergy instead of complexity. Test, verify, apply, retest. Or to adapt Hegel, Hypothesis - Antithesis - Synthesis. |
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