Tradeonix Review: Methodology
The methodology just discussed can be programmed in most software. The method is extremely robust and can be improved with just a few simple discretionary inputs, such as take sell signals at resistance, ignore the buy signals when they are generated near resistance, only take buy signals Pivot Point Analysis, Filtering Methods, and Moving Averages 103 c02.qxd 2/17/07 4:32 Tradeonix Review 103 at or near support, and ignore sell signals. Use the predicted support and resistance levels as profit-setting targets; and, most important of all, wait for the signal to trigger—do not anticipate a signal. This system works across various time periods and under different conditions, such as bullish, bearish, or neutral. This gives it a high rating for being a very robust methodology. As I stated earlier, the parameters I use in this book are a variation of what is programmed in my proprietary library with Genesis software. This is a system that generates buy and sell signals based on the principles we have gone over so far. The greatest feature with this software is that it highlights a sell signal with a red triangle pointing down, and it signals when the trigger occurs to buy with a green triangle pointing up. These signals coincide against resistance levels to sell and support levels to buy. As you will see in many of the charts in this book, when the arrow indicators line up against pivot point support and resistance numbers, it offers a fantastic visual trade confirmation, based on solid technical analysis theory using predefined strategies. It is a system like this that can definitely help traders stay focused and can help reduce the destructive emotional element of fear that forces traders out of winning trades too soon and the greed that generally gets traders to buy the top of rallies. These indicators help traders develop patience by waiting for the actual signals to generate, rather than acting on anticipation. These signals and methods covered in this book can 104 FOREX CONQUERED FIGURE 2.29 Entry Triggers and Profit Target Methods Used with permission of GenesisFT.com. c02.qxd 2/17/07 4:33 Tradeonix Review 104 be applied with most charting packages. In fact, 26 years ago, I was calculating the pivot point support and resistance numbers with a hand-held calculator; and I was not using candle patterns, which show depth and breadth of the current market condition in a colorful manner versus onedimensional single-colored bar charts that we used in those days. One of the neat things about this book is that it comes complete with your own pivot point and Fibonacci calculators. All that needs to be done is to input the data for the high, the low, and the close; and you will have R- 3 down to the S-3 numbers calculated for you. It is very easy to use; all you need are the prices for the forex market for the time frame you wish to research, such as the daily, the weekly, the monthly, or even a quarterly time period. Pivot Point Analysis, Filtering Methods, and Moving Averages 105 c02.qxd 2/17/07 4:33 Tradeonix Review 105 c02.qxd 2/17/07 4:33 Tradeonix Review 106 107 CHAPTER 3 Candlestick Charting T he first recorded futures transactions occurred in the 1700s in the Japanese rice markets, where Munehisa Homma amassed a fortune trading the market. His system included the study of price action, the psychology of the market, and the seasonality of the weather. Candlestick charts evolved from Homma’s system and are the subject of this chapter. This section covers the fundamentals of candlestick charting and explains how to utilize candle charts to analyze, enter, and exit trades. The main advantage that candlestick charting provides over bar charting is that the candlestick provides immediate visual recognition of the open, the high, the low, and the close. Many traders who employ candlestick charting techniques set their charting software so that the candlesticks are one color for a lower close than the open (such as red or black as shown in Figure 3.1) and another color for a higher close than the open (such as green or white as shown in Figure 3.2). For the purpose of this book, a candle with a higher close than the open will be referred to as a white candle. A candle with a lower close than the open will be referred to as a black candle. A single candle does not tell you if the close is higher or lower than in the previous time period. The single candle only shows whether the close is higher or lower than the open for each candle. Each candle has different characteristics that provide insight into price movement by the distance between the open, the high, the low, and the close. The candlesticks formed for each time session also indicate if the price movement shows a level of increasing or decreasing pressure by the size of the candle, or its “real body.” Each candle pictured has a differc03.qxd 2/27/07 4:45 Tradeonix Review 107 ent characteristic that represents the difference or the distance between the open, the high, the low, and the close. Candlestick charting techniques can be used from data for whatever time period you are looking at from as little as one minute to one hour, one day, one week, or one month. The candle still allows for use of traditional Western philosophy of technical analysis of pattern recognition, trend-line support and resistance, and other helpful tools as we will go into in detail in Chapter 5. COMPONENTS OF A CANDLESTICK The components of a candlestick are derived from the open, the high, the low, and the close. The main components that we need to identify are: • Relationship between open and close (the candle bodies). • Real-body colors. • Shadows and correlations to the candle body. • Size of shadows. • Range or length of the candle. In uptrends or bullish market conditions, buying comes in on the open; and the market should settle closer to the highs and should close above the open. That is why in bullish market conditions, we see hollow or white candles. And I assign a higher close than the open. This helps me to identify that buyers are supporting prices. I can tell if the bulls are dominating the market by the distance between the open and the close. If the market opens on the low and has a large range where it closes at the high of the session, that 108 FOREX CONQUERED FIGURE 3.1 Selling, or Short FIGURE 3.2 Buying, or Long c03.qxd 2/27/07 4:45 Tradeonix Review 108 signifies that the bulls are firmly in control. However, if we have a widerange session and the market price closes back near where it opened, let’s say in the middle of the range, that is not a good sign that bulls dominate the market for that particular time period. In a bearish market condition or in a strong downtrend, we would see black or red real-body candles as shown in the accompanying CD. This represents sellers entering the market on the open and dominating the session right into the close of that time period. If the market opens on the high and prices decline where the close is at or near the low, this shows that the bears are firmly in control. This is why I assign these candles a negative (–) reading. The distance factor between the open and the close is illustrated in a much more defined way in candle charts than in bar charts due to the shape and color coordinates. Shadows and Correlations to Candle Body The shadows or wicks are what are made from the distance of a low and/or a high in relationship to the real body as created by the open and the close. They can really illustrate the market’s denial of a support or resistance level. Long shadows or tails or wicks that form after a long downtrend indicate a potential that the trend has exhausted itself and that demand is increasing or supply is dwindling. Shadows formed at the tops of real bodies, especially after a long price advance, indicate that demand is drying up and supply is increasing. The overall size of shadows is important to watch in relationship to a real body and they can be easily identified. Size or Length of the Overall Candle A long real-body candle is hard to miss using the color-coded method of candle charts. An extraordinarily long-ranged candle that opens at the bottom and closes at the high would be an abnormal occurrence and has significant meaning. After a long downtrend, seeing this formation indicates that a major trend reversal is taking place. After a long uptrend, seeing an unusually long candle that closes above the open or a positive value would indicate that an exhaustion, or a blow-off-top condition, may exist. The reverse is true in downtrends; after a long price decline, a tall red or dark candle represents the market closing below the open or a negative assigned value and may indicate that a capitulation or exhaustion bottom has formed. After a long uptrend or price advance, if that same candle was formed, it might indicate that a major trend reversal is occurring. The candle development will give us immediate identification of the current market’s environment and the market participants’ acceptance or rejection of a support or resistance level in a clearly visual manner. Pay Candlestick Charting 109 c03.qxd 2/27/07 4:45 Tradeonix Review 109 special attention to the shadows and closes of ranges in relationship to past highs or lows and to where the market closes. The Doji The secret weapon of candlestick charting is the doji. Dojis indicate indecision; the market close ends where it began, on the opening of the time session. Figure 3.3 shows a full-range high and low with the cross mark across the line, representing that the market has no real body as prices closed exactly where they opened. This goes to show that confidence is lost from buyers or sellers on the open because the market made a lot of intraday noise as the range was established. In a bullish or bearish trending market, indecision is the last thing you want to see. 110 FOREX CONQUERED FIGURE 3.3 Doji Strong rejection or failure from the high and/or the low is a significant telltale sign that changes are coming. In a strong uptrending market, usually the prices will close near a high since larger capitalized traders will hold positions overnight. If the large money traders are not confident that the market will move higher in price, then usually the market closes back near the open. Traders use the phrasing of Newton’s law in the markets an awful lot because it really applies to market moves. “A body in motion tends to stay in motion until a force or obstacle stops or changes that motion.” I believe and teach that the doji represents that force; it generally stops or changes the motion or momentum due to the uncertainty or indecision that is created at peak and troughs. Doji formations help confirm reversals. There are different names and nuances associated with certain dojis, such as the gravestone shown in Figure 3.4, the dragonfly shown in Figure 3.5, and the long-legged or rickshaw doji shown in Figure 3.6. All have the same qualities—they close where the session began. After a major trend has occurred, when one of these candles forms, it signals that the trend is near an end or that there is a change in market conditions. What distinguishes the doji from all other c03.qxd 2/27/07 4:45 Tradeonix Review 110 candle formations is that the close of this candle is nearly exactly at the same price as the open. I am generally a little more lenient with this formation. If after a long-range trading session the close is less than 8 percent of the overall high and low, I consider it a doji. In spot forex markets, if, for example, the British pound had a 150-point range and the market closed within 12 points of the open, I would consider that a doji formation. Candle patterns can be subjective, and there are many variations to each pattern. The key element to this system is identifying where a market closes in relationship to the prior highs or lows. Certain candles have significant meaning besides the doji. Bearish reversal patterns include dark clouds; engulfing, harami, and harami doji crosses; falling three methods; and evening doji stars. These are all indeed powerful setup chart patterns. The reverse of these are the bullish bottom pattern formations, such as bullish piercing, bullish harami, morning doji star, and even the hammer candle. The candle hammer is what I call the “stop,” or “seek and destroy” action. The bearish version is a shooting star candle. The Hammer The hammer shown in Figure 3.7 indicates that a reversal or a bottom is near in a downtrend. When this pattern appears at the top of an uptrend, the name becomes hanging man, and it indicates that a top is near. You Candlestick Charting 111 FIGURE 3.4 Gravestone FIGURE 3.5 Dragonfly FIGURE 3.6 Long-Legged (Rickshaw) Doji c03.qxd 2/27/07 4:45 Tradeonix Review 111 112 FOREX CONQUERED FIGURE 3.8 Shooting Star FIGURE 3.7 Hammer need to know that there are three main characteristics necessary in order for a candle to qualify as a hammer: 1. The real body is at the upper end of the trading range; the color (white or black) is not important. 2. The lower part or the “shadow” should be at least twice the length of the real body. 3. It should have little or no upper shadow, otherwise known as a shaved head candle. The Shooting Star One of the single most important bearish candle formations that I wish to share with you is the star, sometimes referred to as the shooting star candle. It is the inverted formation of the hammer and forms at tops. The shooting star in Figure 3.8 is the reverse of the hammer, but it forms at the top of an uptrend. It usually signals a major reversal. Here again, the color does not matter, but the body should be at the lower end of the trading range with a long shadow. Its significance is that it shows the market opening near the low of the day, followed by an explosive rally that failed and then closed back down near the low of the day. c03.qxd 2/27/07 4:45 Tradeonix Review 112 Usually there is little or no lower shadow, like a shaven bottom. When it is at the bottom of a downtrend, it is known as an inverted hammer. The Morning Doji Star The morning doji star is a major bottom reversal pattern that is a threecandle formation. The first candle has a long black real body; the second candle has a small real body or doji, as shown in Figure 3.9, and gaps lower than the first candle’s body. The third candle’s body sometimes gaps higher than the second one, but this does not happen often. It is important that it is a white candle and closes well above the midpoint of the first candle’s real body. Candlestick Charting 113 FIGURE 3.10 Evening Doji Star FIGURE 3.9 Morning Doji Star The Evening Doji Star The evening doji star shown in Figure 3.10 is the exact opposite of the morning doji star. This is the second-most-bearish top pattern next to the abandoned baby or island top formation. HOT TIP Gaps are not too prevalent in forex trading. Therefore, it is very rare to see a textbook morning or evening doji star formation. In candlestick terminology, a gap is called a “window.” It is said, generally speaking, that if a gap forms or a c03.qxd 2/27/07 4:45 Tradeonix Review 113 window opens, the market will most times trade back to fill the gap or close the window. The trick is knowing when gaps are sometimes “filled” right away and when prices do not return to fill the gap or close the window for quite a while. Gap levels can and do act as support and resistance. So pay attention to the price behavior at these loctions. The Harami The harami is a small real body within the body of the prior body’s candle. This is known as a reversal pattern or a warning of a trend change, especially at tops of markets. It is not important that the colors be opposite, but I notice that the more reliable signals are generated when they are. After a long uptrend, if there is a tall white candle, it can indicate an exhaustion especially followed by a small-real-body candle, as shown in Figure 3.11. 114 FOREX CONQUERED FIGURE 3.11 Harami FIGURE 3.12 Bearish Harami Doji Cross Bearish Harami Doji Cross The bearish harami doji cross shown in Figure 3.12 is a formation that appears when a long white candle occurs, signifying that the market has closed above the open with little or no shadows at both ends of the candle; this candle is then followed in the next time period by a doji within the middle of the white candle’s real body. This tells me bulls no longer dominate. c03.qxd 2/27/07 4:45 Tradeonix Review 114 Bullish Harami Doji Cross The bullish harami doji cross in Figure 3.13 is the opposite of the bearish harami. This pattern will form in a downtrending market. The first candle is usually a long dark candle, signifying that the market has closed below the open with little or no real shadows at both ends; a doji then forms during the next trading session. Candlestick Charting 115 FIGURE 3.14 Dark Cloud Cover FIGURE 3.13 Bullish Harami Doji Cross The Dark Cloud Cover The dark cloud cover is a bearish reversal signal. Usually it appears after an uptrend. The first white candle is followed by a black candle. The important features here are that the dark candle should open higher than the white candle’s high and that the close should pierce well below the midpoint of the white candle’s real body, as shown in Figure 3.14. c03.qxd 2/27/07 4:45 Tradeonix Review 115 The Bullish Piercing Pattern The bullish piercing pattern is the opposite of the dark cloud cover, as you can see in Figure 3.15. It requires that the first candle be a long dark candle and that the second candle gap open lower than the first candle. The other important characteristic is that it closes well above the midpoint of the long dark first candle. Look for 50 percent penetration of the long dark candle. 116 FOREX CONQUERED FIGURE 3.15 Bullish Piercing Pattern The Bullish Engulfing Pattern The bullish engulfing pattern is a powerful setup. Study the pattern as shown in Figure 3.16. It forms when a white candle’s real body completely covers the previous black candle’s real body. It is also relevant to note that the more “wraps,” or past candles, that are engulfed, the stronger the signal. FIGURE 3.16 Bullish Engulfing Pattern The Bearish Engulfing Pattern The bearish engulfing pattern shown in Figure 3.17 is the opposite of the bullish engulfing pattern. When a black candle’s real body completely covers the previous white candle’s real body and even closes below the prior candle’s low, it is a more potent signal. It is also relevant to note that the more “wraps,” or past candles, that are engulfed, the stronger the signal. c03.qxd 2/27/07 4:45 Tradeonix Review 116 Falling Three Methods The bearish falling three methods is a continuation pattern often used like a bear flag formation. The three little candles usually remain within the range of the first black candle that includes both the real body and the shadow. Some argue that it works with from two up to five candles in the middle. The last dark candle closes below the first candle’s close, as Figure 3.18 shows. Candlestick Charting 117 FIGURE 3.18 Bearish Falling Three Methods Rising Three Methods Rising three methods is a bullish continuation pattern with the same characteristics as in the bearish falling three methods but just the opposite. During the beginning stages of an advancing price trend, an unusually long white candle is preceded by three smaller dark or black candles. The three bullish methods pattern needs to stay within the range of the first long white candle. Again, it can have from two up to five candles; but the textbook version is three smaller candles, as Figure 3.19 shows. The last white candle shows a powerful advancing white candle that should open above the previous session’s close and should close above the first long white candle’s close. FIGURE 3.17 Bearish Engulfing Pattern c03.qxd 2/27/07 4:45 Tradeonix Review 117 Tweezers Tops and Bottoms The tweezer is a double-top or double-bottom formation that can be disguised by a few variations. The tweezer top forms after an uptrend followed by two consecutive time periods making an equal high. This signals that there is strong resistance and a short-term top is in place. One variation is that the first day usually consists of a long body candle with a higher close than open (+). The second day is usually an equal-and-opposite-color real-body candle that has a high equal to the prior day’s high. A strong signal exists that a reversal is forming when the second candle’s color is the opposite of the first candle’s color. A tweezer bottom would be the exact opposite of this formation. Other variations are called equal-and-opposite or chopstick patterns. In Chinese, it would be called the yin (black or negative close candle) and the yang (white or hollow positive close candle). At times, these real bodies are not perfectly opposite in size, but they should be close. In Figure 3.20 the tweezer bottom looks more like a pair of thin chopsticks. In Figure 3.21, the tweezer top resembles a pair of fat chopsticks; but notice that the dark candle engulfs the first candle’s real body. That is evidence that a top or a peak price has been established. The equal-andopposite formations occur with false breakouts and key reversals; they are powerful signals that should be respected. 118 FOREX CONQUERED FIGURE 3.19 Bullish Rising Three Methods FIGURE 3.20 Tweezer Bottom FIGURE 3.21 Tweezer Top c03.qxd 2/27/07 4:45 Tradeonix Review 118 YIN AND YANG: THE EQUAL-AND-OPPOSITE TRADE STRATEGY Forex traders take note: These equal-and-opposite patterns show up frequently in the currency pairs as well as in cross-currency markets. We see periods of low volatility between the European and the U.S. sessions; and, as a result, sideways channels form, otherwise known as a longer-term intraday consolidation period. Oftentimes, we see false breakdowns and breakouts that create the equal-and-opposite (yin and yang) formations. We, therefore, have a trigger to enter a position if the market price is near an important pivot point support level. We would buy on the close of the second candle’s time period or the immediate opening of the next time frame. Place a stop at least 10 PIPs (percentage in points) beneath the lowest low point. You should see immediate results as the markets move higher. Adjust your stop accordingly. Figure 3.22 is a 60-minute chart on the euro currency versus the U.S. dollar on July 19, 2006. The exact low occurred at 9:00 A.M. (EST) and was not prompted by any special report. That morning the German Producer Price Index (PPI) came out, but at 2:00 A.M. (EST). Two U.S. economic numbers—housing starts and real earnings—were released; but those reCandlestick Charting 119 FIGURE 3.22 Equal-and-Opposite Candle Revelations Used with permission of GenesisFT.com. c03.qxd 2/27/07 4:45 Tradeonix Review 119 ports were released at 8:30 A.M. (EST), one and a half hours earlier. The dollar got pummeled as U.S. traders started to digest the news. It seems to happen at times that there is a delayed reaction to the economic reports. But looking at the false breakdown of the low of the range that was created in the prior 22 hours of trading shows that an equal-and-opposite candle formed, and it was at that time that the buy programs kicked in as a very powerful reversal took place. In fact, the majority of the move on this 60- minute chart took place in 10 minutes. The market ruthlessly exploded and increased in value over 90 PIPs in just 10 minutes. The 60-minute chart showed an equal-and-opposite pattern. Basically the market went hunting for stops as it broke the low, and shorts covered as the market reversed like a rocket. You need to look for these opportunities because the price action in the forex market behaves like this on a frequent basis. This is a classic failed-pattern breakdown. Traders saw the market making newer lows as prices broke below the low; and when there was absolutely no follow-through, it had a slingshot effect in the opposite direction. This was an ironclad bear trap. By following the rules on equal-and-opposite patterns, especially when a setup fails to materialize, such as a breakdown of support, this is a powerful signal to take a long position. We exercise prudent risk-management techniques placing a stop 10 PIPs below the lowest low point; and as the trade progresses, you can adjust your stop or look to exit if the market gives you a windfall profit that is equal to or exceeds the normal daily range. MULTIPLE TIME-FRAME CONFIRMATION TACTICS Using multiple time-frame analysis will help you confirm a great trading opportunity. Through various time dimensions, if a buy signal is evident, you should see confirming patterns throughout these various time periods. If the 60-minute chart is showing a high-probability bullish reversal pattern, such as the equal-and-opposite candle, then if we break it down to a smaller time frame, we should see signs or bullish patterns as well. Look at Figure 3.23; this is a five-minute chart detailing how the low was formed. We are going to cover the high close doji pattern in the very next section; but for now, I want you to see the magnitude of this strong breakout and the fact that the lower time frame confirmed the higher time frame’s bullish signal. To summarize, there are many candle patterns that indicate reversals. Some are more potent than others, and some work better in various time frames. But many traders have trouble adapting; they get stuck in a rut looking for the same results and fail to exploit highly recognizable pattern failures, such as false breakouts. If you learn to understand the sequence 120 FOREX CONQUERED c03.qxd 2/27/07 4:45 Tradeonix Review 120 and the value of the open close relationship, then you will have a betterthan-average chance of making serious money. The best trades usually come in the form of blindsiding traders who are heavily positioned the wrong way or who have overstayed their welcome in a position. It is this rush for traders to get to the exit door in a panic that accelerates market moves. The equal-and-opposite pattern is a major sign of a false breakout. Think about this: If a market does not do what is expected, such as when it breaks a long-term support and there is no follow-through, who wants to hold a short position in the hole? Not many people. Watch for the yin and the yang, especially at extenuated trend extremes or at congestion points. HIGH CLOSE DOJI SETUP Out of all the candlestick reversal patterns, the high close doji (HCD) is the best and most reliable setup that I have encountered. Figure 3.23 showed a classic pattern on a five-minute chart period. It is based off a simplified morning doji star formation. Instead of looking for the traditional threecandle pattern, this setup merely focuses on the doji and the event that follows the formation of the doji. Candlestick Charting 121 FIGURE 3.23 Candles Light the Path to Profits Used with permission of GenesisFT.com. c03.qxd 2/27/07 4:45 Tradeonix Review 121 Figure 3.24 shows the exact sequence we need: the next one to three time periods after a doji forms to close above the high of that doji candle. That is the key; the close is the confirmation that a bullish transition took place. All that is left is for a trader to act when there is a shift in momentum. In this pattern, we are looking for a specific conditional change to take place in the market, namely, a higher closing high above a doji’s high, especially when it occurs near a pivot point support level. This is the pattern I call the high close doji, or the HCD, method. It has dimensions of specific criteria that need to fall in place, which will help to eliminate and filter out false signals. It is a simple and basic approach that is a high-probability winning strategy. 122 FOREX CONQUERED FIGURE 3.24 High Close Doji Here are the rules to act on when this pattern develops: • Buy on the close or on the next time period’s open once a new closing high is made from the previous time period’s bullish candle reversal pattern or if a doji forms against a pivot number. • Initially, use a hard stop or a mental stop close only (SCO) below the low of the doji. Once the market begins to produce a profit and moves in the desired direction, then you can change to a hard stop and continually trail the stop. Whatever time you are trading, the SCO is specific for that time frame wherever the signal might occur. For example, if it is an intraday signal, then you need to use a mental stop that requires you to wait until the end of the time period, whether that is based on a 5-, 15-, 30-, or 60-minute time frame. Most trading platforms do not have intraday SCO features, rather just the end-of-day SCOs. • Sell or exit the trade on the close or on the first open of a candle that makes a lower low at or near a pivot point resistance calculation. • Use a “filter” or backup process to confirm the buy signal, such as a bullish convergence pattern on stochastic or moving average convergence/divergence (MACD). c03.qxd 2/27/07 4:45 Tradeonix Review 122 The term extreme range expansion, or what I call overoverstretched and unsustainable valuations, is valuable information when it occurs near pivot point calculations. Especially in a runaway bull market, when I start to see a sudden loss of momentum and halting or reversing price action at a resistance level, I certainly consider that I have sufficient cause to begin taking profits from a long position or establishing a new short position. If I see evidence that the move is getting drained by smaller ranges or subsequent closes closer to each low, or if I see a climax with a larger-thannormal-size real body or other evidence that supply is returning to the market, thus turning back price, I start to take several forms of action. I reduce my position by at least one-half to two-thirds and tighten stops. Now, let’s put these rules into practice by examining active trading markets, such as the foreign currency market. The first example, Figure 3.25, is a 15-minute time period candle chart on the spot British pound. Taking the data from September 29 and using the close from the 5 P.M. (EST) New York bank settlement, we have a high of 177.04, a low of 175.92, and a close of 176.13. Once we calculate our pivot points, we have our first support (S-1) figured as 175.68. Our first resistance (R-1) is figured as 176.80. As you can see, the market trades for almost two hours at the pivot support; but at 4:30, a doji forms. Two time periods later, a close above the Candlestick Charting 123 FIGURE 3.25 HCD Triggers Action to Buy Used with permission of GenesisFT.com. c03.qxd 2/27/07 4:45 Tradeonix Review 123 124 FOREX CONQUERED doji’s high occurs. Also note that the market closes above both moving-average values. In addition, the COMAS™ method shows the shorter-term moving average crossing above the longer-term average, confirming a trigger to go long. The trigger to enter a long position would be on the time period’s close or on the very next session’s open; the entry price would be 175.95. As the market blasts off into trend mode, you can see the money-making sequence of events transpire: higher highs, higher lows, and higher closing highs. As the trade matures, watch the reaction at the pivot resistance R-1 of 176.80. Observe the bullish momentum dry up; and for the first time, we have a lower closing low and price closes below both moving average values. The moving averages also form a negative cross, confirming a trigger to exit the long position. As a day trader, you have completed your mission to capture money from the market. This example would have had you exit the position at 176.57. For each full-lot-size contract, that would be a 62-PIP profit, or $620 gain. Granted, we did not buy the low or sell the high, but we certainly did what you always want to do: capture a nice chunk of the middle of a price move. If you understand that markets move from trend mode to consolidation or congestion phase, then you will realize that at this time it is best to walk away, as you are now vulnerable for getting whipsawed in the market. That is why most successful traders make their money and walk away. As you look at the chart in Figure 3.26, notice how the pattern seems to look identical to the pattern in Figure 3.25. The market bases out in a consolidating sideways pattern, a doji forms, the moving averages cross over, and a high close doji triggers a buy signal. Almost instantly, we see positive results as the market makes higher highs, higher closes than opens, and prices are maintaining values above the moving averages. One thing about this particular chart is that the market did not trade down to the S-1 or quite make it to the midpoint between the pivot point and S-1. That is why I use pivot levels as a guide rather than the signal itself. I am interested in what the price action does at the pivot support levels. As we learned earlier, if the market is truly bullish, the pivot point will act as a support level on its own. That is the case in this example; and this is a very important point, so take note. In bullish conditions, the pivot will act as support. Once again, as shown in Figure 3.27, we have a similar pattern as the doji forms at or near the pivot point support level. The pivot support helps target a potential low and a spot where the market may react by reversing direction. We have a few considerations in order to make a trade. For starters, we look for the doji pattern; but it is not until the market closes back above the doji’s high that the trigger to go long is generated. As you see, the moving averages also cross over, and prices close above both moving average values. That is the true trigger to go long; once prices close c03.qxd 2/27/07 4:45 Tradeonix Review 124 Candlestick Charting 125 FIGURE 3.26 The Power of the Doji Signal Used with permission of GenesisFT.com. FIGURE 3.27 The Doji Setup Provides Consistent Results Used with permission of GenesisFT.com. c03.qxd 2/27/07 4:45 Tradeonix Review 125 above the doji high, a higher assigned value has taken place, and the market takes off for almost a 200-PIP move. This market moves immediately with no pressure on the trade whatsoever. I want to now show you how the signals work using the Genesis Software with my formulas plugged in, which identify the momentum shifts with the buy and sell signals indicated by the arrows as shown in Figure 3.28. The system gives buy and sell signals based on the moving averages and on the proximity of the pivot support and resistance levels. In addition, there is an algorithm designated for depicting when a high close doji occurs. As you can see, the buy signal triggers perfectly off the pivot support level; and the market trades right up to the pivot point resistance where a doji forms, alerting you to scale out of partial positions to lock in your gains and to tighten stops accordingly. This is a 15-minute chart; so you can see the system kept you in the trend the entire length of the trade, which was initiated by the high close doji. This trade worked out for $630 per lot or position. To summarize, when you identify a doji at or near the pivot support target level, wait for confirmation of the next candle up to the next three candles to close above the doji’s high. This event of the higher closing high 126 FOREX CONQUERED FIGURE 3.28 Pivots, COMAS, and Candles Generate Consistent Signals Used with permission of GenesisFT.com. c03.qxd 2/27/07 4:45 Tradeonix Review 126 constitutes a higher assigned value, and you should see immediate results to follow. BEARISH TRADING PLAN FORMULA: LOW CLOSE DOJI The next trading signal, the low close doji (LCD), is the opposite of the high close doji. It is a setup developed on the premise that once the market has rallied and established a high, if a doji forms, it is indicating that there is indecision. Then once we establish a lower closing low below the doji’s low, this establishes that there is a loss in bullish momentum and we can initiate a short position. Figure 3.29 shows that the black candle closes below the low of the doji. Candlestick Charting 127 FIGURE 3.29 Low Close Doji Watch for this setup after the market has had an extended advance to the upside; and if it is near a predetermined pivot point resistance level, generally speaking, the market will reach an overbought condition as well. Once the doji appears, it is indicating indecision and weakness of buyers to maintain an upward trend. Those conditions make it ripe for a sharp reversal, allowing for a juicy high-probability, low-risk trade. Here are the rules to act on when this pattern develops: • When prices are at or near a pivot point resistance number, sell on the close or the next time period’s open when a new closing low is made from the previous time period’s (or past three candles) doji. One can use a filter-confirming signal, such as a bearish divergence stochastic pattern or an MACD zero-line cross. • Initially use an SCO above the high of the doji. Once the market begins to produce a profit and moves in the desired direction, then you can change to a hard stop and continually trail the stop. Whatever time you c03.qxd 2/27/07 4:45 Tradeonix Review 127 are trading, the SCO is specific for that time frame, wherever the signal might occur. For example, if it is an intraday signal, then you need to initially use a mental stop that requires you to wait until the end of the time period, whether that is based on a 5-, 15-, 30-, or 60-minute time frame. Most trading platforms do not have intraday SCO features; rather, they have just the end-of-day orders. • Buy or exit on the open of the first candle after the previous candle makes a higher closing high than the previous candle. Let’s examine market price action and how to execute this signal. You have your predetermined pivot point resistance levels already mapped out for you. Once you have the predetermined support and resistance numbers, it is the second variable that is just as important, which is looking for a signal that triggers a call to action. Figure 3.30 is a spot forex euro currency that shows once again why it is important to wait for sell signals at resistance rather than buying breakouts. The euro chart shows the market breaking out above the R-1 level. As a standard rule, I do not like to take buy signals at resistance. I would rather wait for a sell signal to develop and then go with the declining momentum. I believe one reason why this signal works so well is that many traders 128 FOREX CONQUERED FIGURE 3.30 The LCD Pattern Is a High Quality Setup Used with permission of GenesisFT.com. c03.qxd 2/27/07 4:45 Tradeonix Review 128 are trying to trade breakouts of pivot point resistance levels by going long once they see the breakout above the R-1 level. Once there is little followthrough and prices start to retreat, then they are scrambling to sell to get out of their losing trade. In this chart example, notice, too, where we have a moving average crossover and not only do prices close below the doji, but they also close below both moving-average values. The trigger to sell short was executed at 1.2815, and an immediate reaction occurred as prices plunged. The sequence of events that we want to see, as we do in this example, is lower close than the openings; lower highs; lower lows; and, most important, lower closing lows. Now we can make a decision. Instead of keeping the mental SCO above the initial doji high, we could decide that since the move was a decent distance away from our initial entry, we can place a hard stop on the position. As the market enters in a consolidation phase, we see that prices never close above the high of the first reactionary low’s high. That keeps prices contained in a sideways channel or similar to a bear flag formation. As we follow the flow of the market, notice how the market declines by the end of the day to the S-1 of 1.2750. As a day trader, there is no question as to where you need to exit the position. It is the end of the day, and you have managed a trade all day and ridden a very nice trending market condition. This is a great example of how to use the pivot levels for a profit target. Figure 3.31 shows a textbook setup in the Japanese yen. This is a fiveminute chart without the pivot point moving averages overlaid to help you see the progression of the trade and the sequence of the open/close relationship that candlestick charts display. As the market advances toward the projected pivot point daily R-2, traders may assume the market conditions are in a bullish mode. When you get in that mindset, you tend to forget to look at the current market conditions. The top pattern is not a traditional or classic morning doji star formation because the third candle does not close below the midpoint of the tall white candle. However, it does close below the doji’s low. That is the conditional change that takes place, giving us the clue that the bullish momentum has dried up. First, we have a lower closing low; then the market closes below the open, and prices reverse direction once we tapped the pivot point resistance level. Therefore, we want to sell on the close or the very next time period’s open, placing our stop (initially) as a mental SCO above the high of the doji, which is 118.18. That is just three PIPs above the daily pivot point resistance level, too. Again, what we want to see is almost instant follow-through for the price to decline. As you can see, with this trade, there was immediate follow-through. Notice the progression of the market as it declines from the entry price at 118.07 straight down to 117.87, for a quick 20-PIP gain. The market then Candlestick Charting 129 c03.qxd 2/27/07 4:45 Tradeonix Review 129 trades back and forth, creating small-range candles, which form a sideways channel. If you look closely at each candle’s close, notice how it does not close back above the high of the candle that established the first reactionary low. As a trader, you may want to hold all positions or, at this time, cover half of your position. One reason we do that is because, as powerful and reliable as these triggers are, we still do not know the outcome of how far prices can or will actually move. The markets could easily reverse back and challenge the highs. By taking money out of the market, you immediately have profits on half of your positions; and then you also reduce your risk exposure in the market. Examine this chart further and see how the candles show the true direction of the market: The dark candles reflect closes below the open, and there are more of those and they are bigger than the white candles. For the most part, there are more of the dark or negative assigned candles, which are establishing lower closing lows, than there are white or positive assigned candles; but notice that these candles have smaller ranges and hardly ever make higher closing highs. This shows that every time the market rallies just a little bit, sellers are present. Long negative assigned candles represent bears, or sellers, dominating this market. Therefore, staying short on the balance of the position is warranted. Now as the market price disintegrates, demonstrating the conviction of sellers, we can place a hard 130 FOREX CONQUERED FIGURE 3.31 The LCD Pattern Provides Consistent Results Used with permission of GenesisFT.com. c03.qxd 2/27/07 4:45 Tradeonix Review 130 stop at breakeven on the balance of the position and start to adjust the stop to protect profits accordingly. As a short-term trader, it is imperative to trade with the current flow or momentum of the market. Since there are so many variables that can influence your trading decisions, using the methods described here will help you keep focused and alleviate the problems of trading on emotional impulses. When you are focused on what the potential resistance levels are, have learned what to look for (such as a low close doji signal), and then applied trade management techniques, you can capture profits. It is literally up to you to pull the money out of the markets. This method cannot tell you how much money you will make on each trade; every outcome will be different. However, there is a strong possibility that based on historic reference, you will see a decline in prices. In Figure 3.31, we see an immediate reaction as a sequence of lower highs, lower lows, and lower closing lows occurs. In fact, by using the moving averages, you will notice the confirmation of a negative crossover and prices closing below the moving averages as well. This short-term downtrend ends when we see a change in conditions once the moving averages cross back up and prices start to close above both moving-average values. This is a sign that the negative forces or selling pressure are fading and it is time to exit our position. The key is in being able to identify true conditional changes that will make you act on facts, triggering a call to action by a set of rules rather than on emotional impulses. If you have the discipline to trade by a set of rules and follow those rules, you will increase your trading profits. Here are guidelines for trade and risk management: • Get out of half of your positions on the first shift in momentum by a higher closing high, and move your stops. There will be times that you have to make a judgment on whether the risk is too excessive by the distance of the proposed entry and the SCO. • The SCO is for whatever time period you are trading in. For example, if it is an intraday signal, then you need to use a mental stop that requires that you wait until the end of the time period, whether that is based on a 5-, 15-, 30-, or 60-minute time frame. Most trading platforms do not have intraday SCO features, rather just end-of-day SCO. Candlestick Charting 131 c03.qxd 2/27/07 4:45 Tradeonix Review 131 c03.qxd 2/27/07 4:45 Tradeonix Review 132 133 CHAPTER 4 Traditional Chart Patterns FLAG PATTERNS A flag formation or pattern generally develops after significant or abrupt price moves. It is a pausing formation before the trend continues. You want to remember that the body of the flag is generally angled or sloped against the initial trend, as Figure 4.1 shows, but can be found with a sideways pattern. The base of the flag is the starting point for a substantial price advance (or decline, in the case of a bear flag formation). It is then followed by erratic and choppy downward or sideways price action that lasts for several time periods, like a consolidation time or a “time out” before prices continue on. Analysts measure the distance from the bottom of the “flagpole” to the top of the pole (the distance between point A and point B). They then take that distance and measure from the bottom of the flag (point C) and extend it up to the resistance line drawn from the top of the flag pattern (point D), or down to the support line in a bear flag formation, to get an idea of how far prices will move. The length of time that the flag portion of this pattern takes to evolve varies, depending on the time frame in which you are trading. As far as on a daily chart, we should see the breakout occur within two weeks. In daytrading, we should see this pattern evolve within 10 bars, candles, or time periods. Figures 4.2 and 4.3 depict a more common setup, with flags as they occur in the forex market. c04.qxd 2/27/07 4:48 Tradeonix Review 133 134 FOREX CONQUERED FIGURE 4.1 Flags as a Measuring Tool FIGURE 4.2 The Flag Measures out the Price Objective Used with permission of GenesisFT.com. c04.qxd 2/27/07 4:48 Tradeonix Review 134 HOT TIP If a pattern fails to move in accordance with its predisposed tendency, it is generally a great reversal opportunity. For example, if a bull flag does not have the follow-through momentum or upward thrust that is typically associated with the breakout, then it is a failed pattern and can be traded from the short side. TRIANGLE CHART PATTERNS There are three main types of triangle patterns, as shown in Figures 4.4, 4.7, and 4.8 which are symmetrical, ascending, and descending, respectively. A fourth type, known as a pennant formation, resembles the symmetrical triangle—it has two equal sides—as shown in Figure 4.5. The ascending triangles indicate an upward bias, and the descending triangles indicate a downward bias. They are used as a measuring guide for continuation price moves. The length of time, being the distance the “triangle” or congestion area takes to form, is believed to be the distance the market will move once the market “breaks out” of the triangle pattern. Traditional Chart Patterns 135 FIGURE 4.3 Bull and Bear Flags Meet Price Objectives Used with permission of GenesisFT.com. c04.qxd 2/27/07 4:48 Tradeonix Review 135 1. Symmetrical triangles are considered consolidation patterns that occur within a trending phase. The symmetrical triangle develops when prices consolidate as the trading range narrows; the shape forms as prices compress in a coiling pattern. The highs are lower and the lows are higher, as shown in Figure 4.5. As with any time you draw a trend, you need two points of interest, such as two consecutive highs or lows. When drawing out the trend for the triangle, we look for at least four to six points of interest. The true test on determining whether a triangle 136 FOREX CONQUERED FIGURE 4.4 Symmetrical Triangle FIGURE 4.5 Pennant Formation Resembles a symmetrical triangle. c04.qxd 2/27/07 4:48 Tradeonix Review 136 has formed is that prices do not come to test the apex of the triangle. In fact, the reliability of this pattern depends on the fact that the consolidation period in price only reaches three-quarters of the distance to the apex. This pattern is considered a neutral indication, which requires one to watch and wait for a breakout. In order to determine the direction of the breakout, I like to look for a two-period close above the upper resistance trend line. The opposite is true for a breakdown. 2. Pennant formations have the same characteristics as the flag in the sense that they represent a price consolidation after a sharp rally. As Figures 4.5 and 4.6 show, the shape resembles a symmetrical triangle, and the measuring technique is similar to that used with the flag. The difference in the shape of the pennant’s consolidation is obvious compared to the flag. The difference is that pennants take less time to form—generally one week or 10 periods—and lean toward the direction of the price move. In order to use this formation as a measuring tool, we take the distance from the base of where prices started (point A) to the peak or top of the extended move (point B), as shown in Figure 4.6. Consider this consolidation as the midpoint of the overall move, which would give a targeted price projection that would mark point C as the objective for the price move. Traditional Chart Patterns 137 FIGURE 4.6 Pennants Act Similar in Nature to Flags Used with permission of GenesisFT.com. Resembles a symmetrical triangle (also an HCD)! c04.qxd 2/27/07 4:48 Tradeonix Review 137 3. Ascending triangles are similar in nature to symmetrical triangles but have a slight twist in how to use them for price measurement techniques. The bottom trend line slopes up, as shown in Figure 4.7, giving us the clue that the breakout will be to the upside. We can take the widest part of the difference between the upper trend line and the lower trend line and use that amount to gauge how far prices may extend once we see a definitive move. 138 FOREX CONQUERED FIGURE 4.7 Ascending Triangle 4. Descending triangles are the opposite of ascending triangles. The resistance line slopes down, as shown in Figure 4.8. What I do to help determine the true breakout is to watch for a two-period close below the horizontal support line. If you use this pattern to enter a trade, you can FIGURE 4.8 Descending Triangle c04.qxd 2/27/07 4:48 Tradeonix Review 138 use a stop above the resistance line that slopes downward. Measuring the greatest distance from the beginning point of the descending trend line to the bottom of the support line will give you the price measurement; we should see a breakdown in price occur to help determine a profit objective. HOT TIP • Many technicians feel that triangles will have no less than six and no more than eight bounces between the support and resistance lines that determine the triangle formation. We like to see the number three as the “hit” number as that represents triple bottoms and triple tops. • Watch for the false breakout by avoiding trading the pattern until there is a two-period close outside the trend lines. • Watch for pattern failure traps as well. This is when the market moves in the desired direction but suddenly reverses and closes back into the body of the congestion pattern. Let’s examine the euro currency chart in Figure 4.9. The symmetrical triangle is a neutral pattern, meaning it does not give a solid clue as to Traditional Chart Patterns 139 FIGURE 4.9 Single-Close Trap Used with permission of GenesisFT.com. Symmetrical triangle c04.qxd 2/27/07 4:48 Tradeonix Review 139 the direction of the breakout. We want to watch for what I call the singleclose trap, which is what occurs when we see a false breakout on one side for a single period and then an immediate reversal. What you want to focus in on is a sustained price move as prices close at least twice outside the trend lines. Here is how the measuring technique can help you: Take the widest distance between point A and point B, and then extend that down from the break at the apex of the triangle. That measurement will give you your initial price objective. 1-2-3 PATTERNS One of the more reliable 1-2-3 patterns is a “W” bottom. It is also known as a double bottom with a higher right side breakout; and, of course, it is similarly dubbed a 1-2-3 swing bottom formation, as shown in Figure 4.10. The opposite is what we call an “M” top, or double-top pattern, as illustrated in Figure 4.11. You want to be sensitive to these chart patterns due to the higher frequency of occurrences. Not all “W” bottoms have the same type of reaction and come disguised as rounding bottoms or the cup-and-handle pattern. Let’s examine Figure 4.12. As you can clearly see, the 1-2-3 formation was confirmed once the market closed above the first high, or point 2. Once that occurs, look for a two-period close to confirm that prices have adjusted to test a new range expansion. Fibonacci techniques can be introduced in helping to identify point 3. We will generally see a 0.50 percent but more 140 FOREX CONQUERED FIGURE 4.10 1-2-3 Bottom c04.qxd 2/27/07 4:48 Tradeonix Review 140 Traditional Chart Patterns 141 FIGURE 4.11 1-2-3 Top FIGURE 4.12 U.S. Dollar/Canadian Dollar (5-minute bars) Used with permission of GenesisFT.com. than likely a 0.618 percent retracement from the low of point 1 to the high of point 2. The Canadian dollar chart shown in Figure 4.12 is a five-minute chart. We see that prices did trade back as point 3 formed, but never did the price violate or close below the 0.618 percent retracement level. This market broke out once confirmed by the two-period close, which it added on a 48-PIP (percentage in points) gain in less than 50 minutes. c04.qxd 2/27/07 4:48 Tradeonix Review 141 HOT TIP The 1-2-3 bottom formations are the beginnings of an Elliott wave pattern. These are generally some of the most powerful buy signals. Watch for point 3 to hold a 0.50 percent or 0.618 percent Fibonacci retracement. MODIFIED PATTERNS Falling Wedge Patterns A falling wedge pattern is simply a long-term price pattern that resembles a downward sloping triangle formation, as Figure 4.13 shows. The measurement from the distance of the wedge “opening” to the point of the breakout that occurs near the apex gives the extension or measuring distance used to determine a price objective. 142 FOREX CONQUERED FIGURE 4.13 Declining Wedge Watch for the first dip or retest of the trend-line resistance line once the breakout is confirmed. This action usually has prices responding like bouncing off a springboard. Remember the two-period close rule: If prices start accepting the new trading zone outside the wedge formation by more than two periods, odds increase for prices to press or test a new high territory. That’s not to say that they want to wash you out of the game by retracing and retesting the point of breakout. Once again, that point is the upward resistance line. The 30-minute chart on the Japanese yen versus the U.S. dollar in Figure 4.14 helps highlight the sequence of the breakout and retracement job right before the violent and explosive short covering move takes place. c04.qxd 2/27/07 4:48 Tradeonix Review 142 Rising Wedge Patterns Rising wedge patterns are narrowing peaks, as Figure 4.15 illustrates. We can generally see these show up on our radar screens when using moving average convergence/divergence (MACD) or stochastics as they form bearish divergence patterns. We see this formation at the fifth extension wave, which is the end of an Elliott wave cycle. The markets hardly ever reward the masses; and when we see this pattern form, the natural tendency is for traders to overlook the negative implications and only see that prices are making new highs. Be warned, because after a prolonged uptrend, the narrowing effect of each price range that completes the rising wedge gives a clue that prices are ready to reverse. Keep in mind that after a prolonged uptrend, bulls may be overextending their welcome in the trade. A classic example is shown in Figure 4.16, as descending triangle patterns form as prices plummet. You should watch for these narrowing patterns, and keep in mind that the markets can retest the breakdown support line before resuming the descent, as shown in the Canadian dollar chart. Traditional Chart Patterns 143 FIGURE 4.14 Declining Wedges Warn of Sharp Reversals Used with permission of GenesisFT.com. c04.qxd 2/27/07 4:48 Tradeonix Review 143 144 FOREX CONQUERED FIGURE 4.15 Rising Wedge FIGURE 4.16 Rising Wedges Warn of Impending Tops Used with permission of GenesisFT.com. c04.qxd 2/27/07 4:48 Tradeonix Review 144 Sideways Trend Channels A sideways trend channel is a type of flag formation. There is not much to explain on how to identify a channel; the market bounces between two parallel trend lines between highs and lows, namely, the support and the resistance trend lines. Figure 4.17 shows it best. There is a trick, and that is to successfully identify the support or resistance lines early in the channel’s development. Once they are established, traders can go long or buy near the support line or sell short or liquidate longs near resistance lines. The element of risk exists when the market finally breaks out from this channel, or band. Chartists can trade another method of these so-called bands by buying once the market breaks out above the resistance line, as confirmed by two consecutive closes above the resistance line, or by taking a short position once the market breaks below the support line, as confirmed by two consecutive lower closes below the support level. Forex traders will see countless opportunities to trade these patterns because they form frequently. One rule of thumb is that the longer the channel, the bigger the breakout. Also watch out for the false breaks. There are many instances where an equal-andopposite candle pattern will form, thus tricking traders into losing positions. Since sideways channels indicate indecision or a pause, it is only natural for dojis to appear with these ranges. Therefore, I like to watch for shifts in the momentum by trying to spot a high close or a low close doji. Figure 4.18 shows a great example of a low close doji signal within the sideways channel. Treat this setup as you would an LCD pattern. That involves selling on the close of the candle that closes below the doji low or the next time frame’s open. Traditional Chart Patterns 145 FIGURE 4.17 Narrow Sideways Channels c04.qxd 2/27/07 4:48 Tradeonix Review 145 Head and Shoulders Head and shoulders patterns are types of “M” tops. The head and shoulders top or inverted head and shoulders bottom can be used not only as a directional price-indicating pattern but also as a measuring or priceprojecting indicator. A textbook topping pattern is illustrated in Figure 4.19 as the head and shoulders top formation. Head and shoulders tops or bottoms are considered to be strong indicators of major trend reversals. There are four components involved with the head and shoulders pattern: (1) The left shoulder is formed. (2) A higher high occurs forming the head. (3) The development of the right shoulder is formed. (4) The so-called neckline is formed. The symmetry or distance is important. The distance from the left shoulder to the head should be about the same as the distance from the right shoulder to the head. If you measure the distance from the bottom of the head to the neckline, that will give you the next price target level. In other words, by measuring from the bottom of the head to the bottom of the neckline in a head and shoulders top formation, you will be able to project approximately where prices may go. Figure 4.20 shows a perfectly conceived head and shoulders top pattern. If you are looking for a trade based off this formation, keep in mind that this type of pattern is easily recognized by the 146 FOREX CONQUERED FIGURE 4.18 LCD Setups in Sideways Channels Used with permission of GenesisFT.com. c04.qxd 2/27/07 4:48 Tradeonix Review 146 Traditional Chart Patterns 147 FIGURE 4.19 Head and Shoulders Formation FIGURE 4.20 Euro/U.S. Dollar (5-minute bars) Used with permission of GenesisFT.com. masses and, therefore, sometimes does not work. If you sell short, look for a two-period close below the neckline, and make sure the price action does not rally back and take out the high of the right shoulder.