Categories
Forex Basics

Supply, Demand and Liquidity as Drivers of Prices

Markets are “places” where people and institutions exchange assets. It may be stock shares, commodities, grain, livestock, or currencies, but all markets behave similarly. Buyers and sellers look for the best possible price. A buyer seeks to buy at the cheapest possible price, while the seller wants to sell at the highest price.

How prices move

If we order buyers and sellers by the price they are willing to accept, we could see some buyers are bidding an amount very close to the price sellers are asking, and from there, the distance grows in a kind funnel-like shape.

For a sell to occur, one of them must cross the bridge and accept the other side’s price. Also, when a seller moves and takes the ask price for the first time, the “Last price” moves down a little. If another seller does the same, there might be other buyers willing to buy at the same level or not. If there are more buyers at that level, the next seller who takes the ask does not create an additional downward movement. If all buyers disappear from this level, the seller should accept a worse price, moving the asset down, or hold until a buyer takes his bid.

Conversely, if a buyer takes a bid price for the first time, the price of the asset moves up. If other buyers get in and deplete this level from sellers, they should buy at higher prices or wait till a seller takes his ask price.

Supply and Demand

Demand

The demand for an asset decreases as the price increases. The rate of that decline depends on the need for the asset and also on the perceived future value of the asset.

Supply

The supply increases as the price increases. The rate of increment depends mostly on the sellers’ belief about the future price growth of the security.

Equilibrium

Supply and demand are what drives prices up and down. If there are an equal number of buyers and sellers, the price stays at one level and is said to be in equilibrium.

When there are more buyers than sellers, the price moves up until a new equilibrium is reached. Conversely, if the number of sellers is higher, the price moves down until sellers and buyers get the new equilibrium.

Fair Price

The equilibrium is the result of a consensus about the fair price of the security, but fair price changes with the passage of time. The change in fair price may come from technical factors ( overbought-oversold levels, pivot points, breakouts), economic reports such as interest rates, GDP, manufacturing, nonfarm Payrolls, and inflation, or unexpected news events. The new price does not manifest itself in a single and swift price movement because that price is not known at the time. That’s the reason for the appearance of trends.

Liquidity

Liquidity is the term used to define the number of buyers and sellers present in the market.

In a very liquid market, the number of buyers and sellers is vast. Large-sized orders do not affect the price much. Also, bid and ask prices get closer to each other because buyers and sellers compete among themselves to offer their best bid and ask prices. That means spread tightens.

A market with low liquidity shows a scarcity of buyers and sellers. The size and number of operations are tiny, and one small order can produce significant price variations up or down. Also, usually, spreads widen because there is less competition among participants. Low liquidity may cause market manipulations since it is easy to drive prices up or down.

Liquidity does not depend only on the market in question. It changes with the time of the day. For instance, the EURUSD shows less liquidity during the Tokyo session. Then it grows when the European exchanged opens, and it maximizes at the open of the US session. Finally, it fades after Europe closes its markets and traded volume declines further after the US closes.

Final words

  • Supply and demand drive the prices up or down until an equilibrium is reached.
  • The equilibrium breaks by a change in the perception of value by the parties trading it.
  • High liquidity is the key factor for tightening spreads and making markets flow without price manipulation.
Categories
Forex Market

An Overview Of The Forex Trading Industry

Introduction

Some of the most relevant markets include the Stock market, Futures market, Options market, and Foreign Exchange market. All these markets provide vast trading opportunities, and out of these, Foreign Exchange AKA FOREX is one of the most popular ones. Forex is nothing but the exchange and trade of different country’s currencies. The first Forex trading market was established in Amsterdam nearly five centuries ago, and this explains the rich history of this market.

The Forex market is the largest yet most accessible market in the world. Largest because the daily trading volume of the Forex market is above $5 trillion. To put that in perspective, the average daily trading volume of the NYSE (largest stock market in the world) is just above $20 billion. By this, we can understand the enormous size of this market. Out of this $5 trillion, retail trader transactions contribute 5% to 6%, i.e., about $400 billion. The rest of the transaction volume is from large institutions and businesses.

We also mentioned accessibility because traders have thousands of retail brokers around the globe to choose from. They can start trading currencies in this market with investments starting from just $100. Forex trading is open 24 hours a day and five days a week. It doesn’t operate on weekends. On weekdays, the market doesn’t get closed at the end of each business day, like how the stock market does. Rather the trading shifts from one financial center to others. Some of the major financial centers include London, Sydney, New York, and Tokyo.

What affects the Forex market?

One of the critical factors that most of the experienced traders pay attention to is the macro-economic trend. The forex market reacts to macroeconomic data more than the stock or commodity market. In a stock market, we have companies that are affected by micro-dynamics, which are specific to that company. But that’s not the case in the Forex market. This market is affected and moderated by GDP, unemployment rates, and inflation. The currency could react positively or negatively depending on the data, but after reacting, the trend will be maintained for a long time. The significant pairs to watch during such news releases are EUR/USD, USD/JPY, GBP/USD, and USD/CHF. The rate hikes from the U.S. Federal Reserve is also closely watched by traders around the world.

The rise of algorithmic trading

Banks and financial institutions are adopting algorithmic trading systems powered by technological advancement. Technology is changing traders’ approach towards the market. There is a boom in engineered computer programs that offer new ways of creating orders with faster trade execution. The automated systems have improved speed and precision. This technology is expected to eliminate trading bias and human errors that increase the risk in a trade. Algorithmic trading improves trend analysis that greatly helps beginners in reducing losses. Due to this, traders are getting more time to analyze markets and trends.

Future of Forex market

The Forex is continuously growing. Trading currencies is still not a mainstream profession in many of the third world countries. There are still many people who aren’t aware of the fantastic opportunities this industry has to offer. One of the important goals of the brokerage firms is to get more and more people involved in pursuing trading as a serious profession.

  • Market volatility will rise as newer strategies are being released and used by traders.
  • Strict regulation in the forex market will also attract conservative traders. However, some traders search for unregulated brokers since they provide inexpensive trading services.
  • Paid systems and strategies will continue to grow among wealthy investors.
  • Trading Forex is getting easier and extremely accessible with the advent of smartphone trading applications.

Bottom line

The Forex industry has changed significantly over the years. Many efforts are being made to create a legitimate trading environment as the industry has become more dynamic and ever-changing. Major European regulators are taking serious steps to tighten control of the Forex market. Besides, they are also introducing new rules to forbid high leverage trading to protect investor’s funds.

A known fact about Forex trading is that most traders fail. It is estimated that 96% of the people end up losing. To be in the succeeding 4%, one should have a disciplined approach to the way they trade. Some of the practices include starting with low capital, managing risk, controlling emotions, and accepting failures. If you follow these rules, you are on track to becoming a successful trader.

Also, education plays an essential role for someone to succeed in their Forex trading journey. We at Forex Academy designed a course just for our readers. By taking up this free course, one can learn everything about Forex trading even if they have zero experience. You can find all of our course articles here.

Got any questions? Let us know in the comments below.

Categories
Forex Basic Strategies

Moving Average Strategies: Three Simple Moving Averages Part 2

In the article “Moving Average Strategies: Three Simple Moving Averages Part 1”, we have come to know how three simple moving averages on a chart help us detect a trend. In this article, we will demonstrate how and where to take entries with the help of ‘Three SMAs”.

A Moving Average is an indicator that shows trends as well as it acts as support/resistance. In a buying market, it acts as support whereas it serves as a resistance in a selling market. Let us have a look at how it works as resistance and offers us entries in a selling market.

We have inserted “Three SMAs” with the value of 200, 100 and 50 on this chart. The chart shows that the price has been down-trending nicely as far as “Three SMAs” rules are concerned. Please notice that every time the price goes back to the 50- Period Simple Moving Average, it comes down. However, in some cases, the price makes a bit bigger move than the others. We need to understand which one is to make a bigger move and offers us an entry. Can you spot out the differences?

Have a look at the same chart below.

Look at the arrowed candle. The price comes down with a better pace and travels more after those marked candles. There are several reasons for this.

  1. The price goes back to the 50- Period Simple Moving Average; touches (or very adjacent to it).
  2. The bearish reversal candles are engulfing candle.

In some cases, the price starts down-trending without touching the 50-Period Simple Moving Average, it does not travel a good distance towards the downside. It rather goes back again; touches it and then makes a bigger move.

At the very left, the first arrowed candle, the bearish engulfing candle does not touch the Moving Average, but one of the bullish candles has had rejection at the 50-Period Simple Moving Average, thus this is an entry. However, see the very next candle comes out as a corrective candle. This means the sellers are not that sanguine since the bearish reversal candle is not produced right at the 50-Period Simple Moving Average.

With the second and third arrowed candles, they are produced right at the 50-Period Simple Moving Average and both of them are bearish engulfing candles. Those two are perfect entries as far as ‘Three SMAs’ is concerned.

At the very right, the last arrowed candle is very adjacent to the 50-Period Simple Moving Average and produces a bearish engulfing candle.  Most likely, the price would head towards the South again. However, “Three SMAs” does not recommend that we shall take an entry here.

We will learn more strategies with Moving Average in our fore coming articles. Keep in touch.

 

Categories
Beginners Forex Education Forex Indicators

How to Properly Interpret Volume

Volume

Historically, and this is especially true in traditional equity markets, volume is often the most important indicator out there. Some people argue that volume is not overly reliable in forex markets. There is a significant debate on whether volume should be considered as important in forex markets as it is in equity markets due to the drastic differences in the amount of volume from one broker to another. Others believe that it is already (we can see volume from many of the exchanges). For the stock market and futures and almost any traded instrument, volume tells you what people are doing. And what they are not doing.

Volume helps you spot reversals and can tell you if the reversal candlestick is a ‘true’ candlestick. For example, in the image below, the hammer candlestick forms at or near the end of a downtrend. However, this candlestick (and those before it) should have increased and above-average volume. A hammer candlestick on high volume in a downtrend can be a great signal when you accompany it with another indicator, like the RSI.

Look at number one. The arrow is pointing to a very large hammer candlestick; the volume column is massive and definitely above the average volume (orange line average volume). If we look at the RSI, it is oversold. Those can be great conditions for going long!

Candlestick Principles with Volume

Volume is an extremely important component of any candlestick. A candlestick tells us what happened to move price in that period, but volume tells us how hard people fought for that movement and how much conviction was in that move. Here are some principles about candlesticks to keep in mind.

  1. The length of any wick, either the top or the bottom, is ALWAYS the first point of focus because it instantly reveals strength, weakness, indecision, and (more importantly) market sentiment.
  2. If no wick, then that signals strong market sentiment in the direction of the closing price.
  3. A narrow-body indicates weak sentiment. A wide-body represents strong sentiment.
  4. A candle of the same type will have a completely different meaning depending on where it appears in a price trend.
  5. Volume often validates price – Any candlestick that closes at or near an important high or low should be watched very closely for how much volume was involved.

 

High volume near highs and lows

Volume can give a clear, early warning that a current trend (long term or short term) may be coming to an end. If you observe price moving lower, but volume starts to increase and become greater than a 20 to 30-period average, then you may be looking at the bottom of a move. In other words, the market may reverse and become bullish. Observe the chart below:

  1. Price is declining as the price is dropping. That is a clear sign that no one is interested in buying or supporting higher prices.
  2. As prices have continued to make new lows, notice how the volume begins to spike higher – well above the most recent candlesticks volume.
  3. This increase in volume indicates more participation and is generally a combination of new entrants going long (buying), and those current traders who are short, have to cover and convert to long. That volume becomes a powerful variable that reverses the price action.

Key Points

  1. Look to see if the current chart is showing new and important highs or lows.
  2. If new highs or lows are present, observe the volume indicator. If it is rising, then that can mean the current price action may reverse.
Categories
Forex Basic Strategies

Moving Average Strategies: Three Simple Moving Averages Part 1

Moving Average (MA) is the most widely used indicator which has long been used by the traders in the financial markets. It is a trend detecting indicator. Since detecting trends is one of the most important key components of trading, visual representation of a trend by Moving Average makes it be a favorite indicator among the financial traders.

There are multiple Moving Average strategies used by traders. In this lesson, we are going to learn a strategy called “Three SMAs”. It is a strategy with three Simple Moving Averages; these are Simple Moving Average 200, Simple Moving Average 100 and Simple Moving Average 50.

Let us now have a look at how a chart looks like with “Three SMAs”.

This is how the charts look like most of the time. The red one is 200-period Simple Moving Average, the yellow one is the 100-period SMA and the blue one is  50-period SMA. It is better to use different colors so that we can identify them easily.

In the chart above, we see that the price gets caught in between those Moving Averages to start with. The price comes further down, but the 50-SMA stays between the100-SMA and the 200-SMA. What does “Three SMAs” suggest to us here? It suggests that the price does not have a solid trend.

In the naked eyes, the price action suggests that the asset is down-trending. However, by having “Three SMAs”, we can identify solid down-trend has not been established yet. This is why many price action traders use “Three SMA’s” to be sanguine about the trend. Ideally, this is not a chart that we should look for entries.

The question is how a trading chart should look like with “Three SMAs” to look for entries. Let us have a look at the chart below.

The difference is very evident here. See how they have been lined up. Moving Average 200 stays on the top; Moving Average 100 stays in between; Moving Average 50 stays at the bottom. This is an ideal chart with “Three SAM’s” to look for short entries.

In the case of price is up-trending, this is how it looks like.

In a buying market, they are to be lined up just another way round than the selling market. Look at the chart above. The Moving Average 200 stays at the bottom, Moving Average 100 stays in between and Moving Average 50 stays at the top. In this chart, we shall look for long entries.

“Three SMAs” indicators work wonderfully well with intraday trading. In this lesson, we have used a 15-minute chart and three SMAs with periods of 50,100 and 200. If we want to use other charts such as H1 or H4, we have to change the values. However, the best combination for “Three SMAs” is Moving Averages of 50,100 and 200 on the 15M chart.

We now understand how “Three SMA’s” may help us understand the trend.  Thus, “Three SMA’s” may be integrated with any other strategies for taking entries. Moreover, only “Three SMAs” itself offers us entries as well. In our next article, we will demonstrate how entries are to be taken based on “Three SMAs”.  Stay tuned.

Categories
Forex Candlesticks

Ideas that can be Blended with Candlestick to Trigger Entries-Part4

In this article, we are going to demonstrate how a Morning Star offered us an entry. We know Morning Star is a strong bullish reversal candle, which is a combination of three candlesticks. There are two types of Morning Star.

  1. Morning Star
  2. Morning Doji Star

Here is how Morning Star looks like

And this is how Morning Doji Star looks like

The example we are going to demonstrate is a Morning Doji Star. Let us get started.

The price was down-trending and produced a Doji Candle on a support level where the last bearish candle closed within. Look at the very last candle. It came out as a Bullish Marubozu Candle closing above the 2nd last candle’s open. This is a typical example of Moring Star upon which buyers shall start integrating other equations to go long.

Let us have a look at those equations.

At first, we have to draw a level of resistance here. Let us draw it.

We draw the resistance line right where the candle closes. Since we do not have any down-trending Trend Line or a Double Bottom’s neckline here, thus we must wait for a trigger candle to close above the bullish candle on the trading chart.  We now have to flip over to the trigger chart. This is an H4 chart, so let’s flip over to the H1 chart to get correction/consolidation and breakout.

This is how the H1 chart looks. The first H1 candle came out as a bearish corrective candle, and the very next one closed above the bullish H4 candle’s close. A perfect trigger candle, we shall wait for. We sometimes may not get the corrective candle here. The very next H1 candle may breach the resistance line and offer us the entry.

In our previous article, we demonstrated an example of how a Bearish Engulfing Candle offered us an entry. Have you spotted out the difference between a single candlestick pattern and a combination of candlesticks pattern’s entry?

On a single candlestick entry, we had to wait for a neckline breakout (it may be trend line breakout), consolidation (on the trading chart), bearish reversal candle (on the trading chart), then the breakout (trigger chart). With Morning Star, we did not have to wait for consolidation on the trading chart. Once the combination pattern (Morning Star) was evident, we flipped over to the trigger chart; waited for a candle to make a new higher high to take an entry.

It may sound so many things to be remembered and integrated with candlesticks trading. However, once we practice and try to understand the market psychology that goes with those patterns, things will get as easy as you may like.

 

Categories
Forex Chart Basics

Ideas that can be Blended with Candlestick to Trigger Entries-Part 3

In Part 2, we learned how important a breakout is for taking an entry. Even the strongest reversal candle itself is not enough to create a new trend. In this article, we are going to learn other steps that we need to maintain for taking an entry in case of engulfing candlestick.

Let us have a look at the chart below.

After producing the engulfing candle,

  1. The price breached through a support level.
  2. The breakout candle looks very strong.

First two equations have been met. Shall we take the entry right now? The answer is “NO”. We must wait for an upward correction/consolidation. A correction/consolidation gives us another level of support/resistance (in this case resistance). It offers a better risk and reward ratio as well as a better winning percentage. Thus, correction/consolidation is considered one of the most vital components of trading.

Let us have a look at how consolidation took place here.

Pay attention to those candles after the breakout. The pair produced one more bearish candle. Many traders may think an opportunity missed here. Look at the very next candle. That came as a Doji Candle followed by a bullish one. Be very careful. The market often keeps having a correction and changes the trend even by making new higher highs. Thus, a bearish reversal candle we must wait for.

We got one and luckily, it was a bearish engulfing candle. Candle Stick Pattern is being used here again to show us selling sign. What do we have to do now?

We have to wait for another breakout. This time we have to flip over to our Trigger Chart. This is an H4 chart. Thus, our trigger chart is H1 Chart. Let us flip over to the H1 Chart.

The price came out with the last candle from the consolidation zone. A Marubozu Bearish Candle made the breakout. A less low spike indicates that the sellers are very confident. Look, Candle Stick Pattern is being used here again. Here we go. This is the point where we trigger out short (sell) entry.

Let us have a look at the chart below how our trade would play.

Wow, it played well. Though it had consolidation on the minor time frames later, however, this should not be our concern. We followed our trading chart’s trend, breakout, consolidation (H4) and the H1 breakout. By setting our Stop Loss and Take Profit, we shall forget the entry. This is another thing of trading called “Set and Forget” that need to be integrated.

In this article, we learned these are the things to be integrated as well.

  1. Consolidation/ Correction on the trading chart.
  2. Reversal candle to be formed on the trading chart.
  3. Flipping over to the trigger chart and waiting for a breakout.

In the next article, we are going to demonstrate an example of how a Morning Star offered us entry with the integration of consolidation, breakout, and breakout candle with a Morning Star. Stay tuned.

Categories
Forex Candlesticks

Ideas that can be Blended with Candlestick to Trigger Entries – Part 2

Candlestick Patterns are widely used by traders to take entries and making money out of trading. We have come to know from Part 1 that relying on a candlestick formation only is not enough for a reliable entry signal. Other things need to be integrated with candlestick formation so that traders can trade accordingly. In this article, we are going to demonstrate an example of how an entry should be taken depending mainly on an engulfing candle as well as other equations that need to be maintained by traders.

Let us have a look at the chart below.

The chart above shows that the market is up-trending. At first glance, we shall look for buying opportunities here. However, look at the last candle. This is an engulfing candle which indicates that the sellers may take over. An engulfing candle is a strong sign of a trend reversal. However, we must not get carried away, but wait for other indications. In this case, we may wait for a breakout at the last swing low. Have a look at the chart.

Pay attention to the red line. This is the last swing low where the price had a bounce and moved towards the North. Then, after finding a resistance, it produced a bearish engulfing candle; kept going down on the next candle and made a breakout with a huge bearish candle. This is now an ideal chart for the sellers to look for selling opportunities. The trend starts with an engulfing bearish candle. Candlestick pattern suggests that the sellers may take over. It has. It is pretty simple, right? Not really. Just go three candles back. Look at the same chart below.

Pay attention to the arrowed candle. This is a bearish engulfing candle as well. That could have changed the trend and the price could have headed towards the South. However, that did not happen. The price kept going towards the North for three more candles then came down. Do you spot out the difference? The price did not make any downside breakout. In this case, if it had made a breakout at the nearest swing low, it might have come down from right there. Look at the chart below to get a better idea of which level I am talking about.

The drawn red level was the last swing low. If the price continued to go down and made a breakout at that level, it would have been a different ball game.

In this lesson, we have learned that Candlestick Pattern is a sign. In fact, is the first sign of a trend reversal. However, we need at least two more things to integrate with Candle Stick Pattern for taking an entry. These are:

  1. A Breakout at a significant level of support or resistance.
  2. The breakout is to have good momentum meaning the breakout candle is to be a good-looking bullish or bearish candle.

 

Stay tuned to get to know more about candlestick and integration in Part-3.

Categories
Forex Candlesticks

Ideas that can be Blended with Candlestick to Trigger Entries-Part 1

Candlesticks are considered one of the strongest components to take an entry. However, this is not the only thing that a trader shall consider before taking an entry. An Engulfing Candle or a Pin Bar is a strong reversal candle. If the price is down-trending and we get a bullish engulfing candle, we may want to go long on the pair. No doubt, a bullish engulfing candle is a strong reversal candle, but there are other factors we must consider before taking an entry.

Let us find more about it from the charts below.

I have chosen a chart which was down-trending and produced a Bullish Pin Bar. The price then changed its direction and headed toward the North. Let us have a look at the chart.

The arrowed candle is one good-looking bullish Pin Bar. A Pin Bar like this attracts the buyers to go long. We see the consequence; the price headed towards the North with good buying pressure. Does this mean whenever we see a Bullish Pin Bar, we go long or vice versa? The answer is no. We must consider other factors such as Support/Resistance zone, Double Top/Bottom, Neckline Breakout, Trend Line breakout, Breakout Candle.

Let us have a look at the chart again.

See where the Pin Bar was formed. It was formed right at a zone where the price had several bounces. Ideally, this is a level where the sellers want to come out with their profit. Thus, a strong bullish reversal candle such as a Bullish Pin Bar shall attract the buyers to concentrate on the chart to go long. Now that we have found a strong support level what else to look for?

The price was down-trending by following a Trend Line. Can you spot that?

Have a look at this.

A down-trending Trend Line can be drawn. Buyers must wait for a breakout there. See the breakout candle. That was a strong bullish candle which was followed by another one. Moreover, the price came back and touched the Trend line after the breakout. Many buyers may have taken their entry there. This is not a bad idea. You may want to go long right after the second candle closes.

However, some buyers may want to go long at the neckline breakout. Have a look at the chart below.

To be very safe, some traders love to set a pending buy order and go long above the neckline level. It is a safer option for sure, but it has some disadvantages as well. We will talk about this later. Meanwhile, concentrate on what we have learned from this article.

  1. Candlestick or Candlestick pattern is to be formed at a value area.
  2. The existent trend is to be collapsed.
  3. Double Bottom or Double Top is to be evident.
  4. Breakout Candle is to be a strong commanding candle.

 

 

Categories
Forex Candlesticks

Morning Star: A Strong Bullish Reversal Candlestick Pattern

The Morning Star is a bullish reversal pattern that occurs at the bottom of a downtrend. A Morning Star is a combination of three candlesticks: The first candle shows the continuation of the downtrend. The second candle shows the weakness, and the third candle shows the strength of the bull.

There are two types of Morning Star:

  1. Morning Star
  2. Morning Doji Star

 

Morning Star

The Morning Star starts with a strong bearish candle followed by a gap down. The star candle may have a little bullish or bearish body. However, the third candle is to be a strong bullish candle closes at the above of the first candle’s open.

Have a look at this.

See the first candle, which is a strong bearish candle. The next candle starts with a gap closing as a little bearish candle. This one may have a small bullish body in some cases. The third candle starts with another upside gap. It is to be a strong bullish candle closing at the above of the first candles’ open. This states that the bull has taken control of the bear.

 

Morning Doji Star

 

Let us have a look at the Morning Doji Star

In this case, the star candle comes out as a Doji candlestick. The first candle comes as usual as a strong bearish candle. The third candle opens right at the support level and finishes above the first candle’s open. It states that buyers have started dominating the market.

 

In both cases, the first and third candles’ attributes are the same. The second candle varies. However, both types explain the psychology of the market, showing that the existent downtrend has come to an end, and an uptrend has been formed.

The Morning star is a visual pattern that is spotted out by the traders easily. It is the preferred pattern among all kinds of traders from price action traders to traders based on indicators.

How Traders Based on Indicators/Price Action Use the Morning Star

Traders based on indicators may use the Morning Star when it is produced at the Supply/Support zone. Moving Average, RSI, Bollinger Band, Parabolic SAR indicate Supply/ Support zone. If a Morning Star is produced at the zone that is a supply/support zone of those indicators, an entry may be triggered at the close of the third candle.

The price action traders may use horizontal, Trend Line, Fibonacci Support/Supply zone to take en entry on the Morning Star. If a Morning Star is produced at the supply/support zone of a horizontal/Trend Line/ Fibonacci levels, an entry may be triggered right after the close of the third candle.

 

 

 

 

Categories
Forex Daily Topic Forex Range

Hidden Wisdom Behind Range Measures

People coming to the Forex markets usually learned new vocabulary. The first special words they learn maybe are, margin, profit, risk-reward, and candlestick. Perhaps, afterward, they learn new concepts such as Volatility. Also, along with other technical indicators, they get to know one study called Average True Range. However, later, they forget about it since they usually consider it unimportant.

The Average True Range (ATR) is one way to measure Volatility. Volatility is, as we know, a measure of risk. Therefore, ATR can be used as an estimate of our risk. This measurement is essential for us as traders, especially if we are trading on margin. And I’ll explain why.

 

What tells the Range?

A range is a measure of the price variation over a period of time. It is measured between the High and the Low of a bar or candlestick. For instance, the range of figure 1 below (a 4H chart) is 357.9 points. If each point/lot were worth $1, a short position started at the Low of the bar would have lost $357.9 in four hours on every lot traded. Conversely, a long position would get this amount of profit.

True Range

True range is similar to a normal Range, but it takes into consideration possible gaps between bars. That happens a lot in assets that do not trade all day. Not always the close of a session matches the open of the next one. A gap may form. A True range accounts for that by considering gaps as part of the range of the bar if the gap is not engulfed by the range.

Average True Range

As we can see, in the figure above, every bar’s range varies depending on the particular price action on the bar. Some bars are impulsive and move considerably. Other bars are corrective, and their range is short.

Therefore, to measure the average price range an average is taken, usually, the 14-period, although traders can change it. Below we show the 10-bar ATR of the Bitcoin.

On this figure, we see that the ATR gets quite high at some point on the left of the figure, and it slowly decreases in waves. That is normal. Assets move in a series of increasing and decreasing volatility waves, which describes the interests and power of buyers and sellers.

Average True Range and Risk.

Retail traders usually have small pockets. The first measure a retail trader should know is how much his account would endure in the event of an adverse excursion.

As an example, let’s examine the EURUSD daily chart. Observing the 10-ATR indicator in the chart below, we see that the maximum level on the chart is 0.01053 and the minimum value is 0.00664. Since we want to assess risk, we are only interested in the maximum value.

Let’s assume that we wanted to trade long one EURUSD contract at $1.1288 and that, on average, our trade takes one day to complete. How much can we assume the price would move in a single day?

If we take the 0.01053 as its daily range value and multiply it by the value of a lot ($100K) we see that the EURUSD price is expected to move about $1,053 per day. We don’t know if that will be in our favor or not, but from the risk perspective, we can see that to be on the safe side we would need at least $1,053 of available margin for every lot traded.

If the average trade, takes 4 or 8 hours instead, we should set the timframe to 4H or 8H and proceed as we did with the daily range.

For not standard durations, we could use the following rule: For each doubling in time, the average range grows by a factor of the square root of 2.

That is handy also to compute the right trade size. Maybe we do not have the required margin level, but just one fourth. Thus, if we still wanted to trade the asset, we should trim down our bet size to one-quarter of the lot.

How much time our stop-loss will endure?

Based on ATR figures, we could assess the validity of a stop-loss level. If the stop-loss size is too short compared to the ATR, it might be wrongly set.

What profits to expect?

We could assess that as well, on average, of course. If the dollar range of an asset is $1,000 in a 4-hour span, we can expect that amount on average in four hours, and $1.410 (√2 * $1,000) on an 8-hour lapse.

Deciding which asset to trade

We could use the True Range to assess which asset is best for trading. Let’s suppose, for instance, that you are undecided about trading Gold (XAU) and Platinum (XPT). So let’s examine them.

Gold:

Spread: 3.2

$Spread cost: $32

Digits: 2

contract size: 100

MAX Daily ATR: 16, $ATR: $1600

Spread cost as Percent of the daily range: 2%

Platinum:

Spread: 12.9

$Spread cost: $129

Digits:2

Contract Size: 100

Max Daily ATR: 22, $ATR $2,200

Spread cost as Percent of the daily range: 5.86%

After these calculations, we can see that it is much wiser to trade Gold, since the costs slice only 2% of the daily range, while Platinum takes almost 5% of the range as costs before break even.

 

Categories
Forex Candlesticks

Types of Bullish Candlesticks

In this article, we are going to get acquainted with some of the Bullish Candlesticks that the financial markets produce. Let’s get started.

 

Bullish Trackrail

Bullish Trackrail candlestick indicates that the market has been dominated strongly by the buyers. It is a combination of two candlesticks. The second candle is to be bullish and the length is very similar to the first candle. Both candles are with a long and solid body having tiny spikes or no spike at all.

Image: Bullish Trackrail

Bullish Engulfing

Bullish Engulfing Candle is formed with a combination of two candles. The second candle is to engulf and close above the first candle to be considered as a Bullish Engulfing candle. Some analysts/traders do not want to take first candle’s wick into account. However, if the second candle closes above the first candle’s wick, that is one good Bullish Engulfing Candle. A Bullish Engulfing Candle is considered as the strongest bullish reversal candle.

 

Image: Bullish Engulfing

Bullish Hammer

Bullish Hammer Candle is created when a candle closes with a small body with a long lower shadow. The body has to be tiny and it can be bullish or bearish. However, a little bullish body instead of a bearish body is more preferable among the buyers.

Image: Bullish Hammer

Spinning Top      

Spinning Top has a short body found in the middle with upper and lower wicks. The body can be bullish or bearish.

Image: Spinning Top

Bullish Pin Bar

Bullish Pin Bar is similar to Bullish Hammer. The only difference is a Bullish Pin Bar does not have any real body whereas a Bullish Hammer has a tiny body. Since a Pin Bar does not have a body, it has more rejection from the downside. Thus, Bullish Pin Bar is considered one of the most powerful bullish reversal candlesticks in the financial market.

Image: Bullish Pin Bar

Bullish Inside Bar

Bullish Inside Bar is produced with a combination of two candles. The second candle is to be bullish but shorter than the first candle. It is just the opposite of Bullish Engulfing Candlestick. A Bullish Inside Bar is considered the weakest bullish reversal candlestick.

Image: Bullish Inside Bar

Doji

A Doji Candle is formed where the price finishes very close to the same level. Thus, the candle has no body or a very tiny body. A Doji Candle itself is not a strong bullish reversal candle. However, if it is produced at a strong level of support, the market often reverses and goes towards the North.

 

 

Image: Doji

Bullish Spinning Top and Doji look very similar to the Bearish Spinning Top and Doji. The only difference between a Bullish Doji and Bearish Doji is a Bullish Doji is produced at a Support Level whereas a Bearish Doji is produced at a resistance level. The same goes for Spinning Top as well. All other bullish reversal candles’ are to be formed at a significant level of support as well. Their appearance is very different than the bearish reversal candles. Stay tuned with us to learn more about Candlestick.

 

 

Categories
Forex Candlesticks Forex Daily Topic

Three Facts about Candlesticks you Never Knew About

Candlesticks are great because it makes trends visual at first glance. But most candlestick users stay just with that trait and don’t go more in-depth.

Of course, everybody knows some candlestick patterns such as Morning and Evening Stars, Haramis, Dojis and Shooting stars, but what’ is hiding inside the candlestick?. How to extract market sentiment from its shape or pattern?

So, let’s begin!

1 – Unwrapping a Candlestick

A candlestick is condensed information of the price action within its timeframe. The corollary is that if we go to a shorter timeframe, the candlestick now is a pattern of several candlesticks.

In the chart here we see the unwrapping of a 4H candle into 30-min parts

Three Facts about Candlesticks you Never Knew About

Chart 1 – 4H Hammer Candlestick unwrapped into 30-min candles.

 

We notice that the candle has one segment dominated by sellers and the other part controlled by buyers.

Which sentiment dominates in sellers at the bottom?

  • To the first class belong those traders who could no longer hold the pain of being long and close their position.
  • The second class is made of those who came late to the trend and sold believing the trend will last forever, or quite so.

Which sentiment dominates in the way back up?

  • Late sellers realized that they were in the losing side, so they needed to close their shorts. That meant, they have to buy, adding to the bullish fuel
  • Longs that were taken out of their position see frustrated how the price moves up without them. Hence, some of them retake their longs, while others don’t dare, afraid this is going to be another bull squeeze.

2.- Impulse or correction?

There are only two stages in the market: Impulses and corrections of previous impulses. So how to spot the price is in an impulsive or corrective phase?

Three Facts about Candlesticks you Never Knew About II

Chart 2 – Candlesticks: impulses and corrections.

Impulses break resistances and move with a clear direction. Impulses are what make trends. Corrections move in ranges, lack direction, and usually retraces some or all the advances of the previous impulse.  People usually think in trends as composed by many candlesticks or bars, but we now know that a single candlestick is composed by many shorter-timeframe candlesticks. Therefore, we cannot be surprised if we state that a trend can be made of a single candlestick. That applies also to corrective movements. A corrective movement can be summarised in a single candlestick.

How to know if a candle is impulsive or corrective?

To spot an impulse look for a candlestick with a large body and almost no wicks or shadows. To spot a corrective movement look for small-bodied candles with or without wicks ( usually with wicks).  Sometimes we find both characteristics in a candlestick. That may mean it is a combination of impulse and correction. That is ok since there is no law that forbids the start of a correction or impulse in the middle of the timeframe of a candle. Sorry, the universe is not perfect!

3.- Who is in control?

Once we know facts 1 and 2, we are in the position to spot who controls the price action: buyers or sellers.

One clue is, of course how the candlestick closes, but the other clue is where are and how long are wicks. If we spot several candlesticks with large lower wicks we could reason that the buyers are pushing the price above the bottom of the candlesticks. If wicks happen on top we could deduct the opposite: Sellers selling the rally.

Three Facts about Candlesticks you Never Knew About III

Chart 3 – Candlesticks: Wicks show who controls the price action

A downward trend with a lot of lower wicks is weak. That applies to an upward trend with lots of upper wicks.  Therefore, we can detect the market sentiment by just observing the wick appearance on the candlesticks.

 

Final words

So now we know that there is much more than just fancy colors and trend visualization. We have to inspect and pay attention to body and wicks, also called shadows by Steve Nison. The information provided by a single or a group or candlesticks is worth the time spent.

 

Categories
Forex Chart Basics

Candlestick Charts and Its Advantages in Financial Trading

With the advancement of technology, retail trading in the financial markets has become popular among investors. Since unnumbered traders from all over the world invest in the financial markets, they use so many of strategies, indicators, and EAs to make money out of trading. Also, many things with the financial markets have been changing as well. However, certain basic things have no, and they may never change. One of the things is the usage of Candlestick charts.

Before getting into this, lets us summarize the different types of charts available for traders. Typically, there are three types of charts that are mostly used in trading.

  • Line Chart
  • Bar Chart
  • Candle Stick Chart

Line Chart

Let us have a look at a line chart.

The line chart is generated by using the closing price of the bars. It does not represent the highest high, lowest low or the opening price. Thus, it gets tough for traders to find out the sentiment of other traders. The price may go towards the upside and has a strong rejection from a level of resistance. But the line chart does not show that rejection. Thus, a trader may think the market is bullish whereas the price has had a strong rejection and it may be time for the sellers to take over.

Let us flip over the same chart to a Bar Chart.

The Bar Chart is more informative than the Line Chart. It shows the opening price, closing price, highest high and lowest low of the period it has tracked. It certainly gives us a clearer picture than the Line chart. An experienced trader may not have any problem to find out the trend, rejections, market psychology by using the Bar Chart. However, we may have a better option. Do you know what that is? It is the Candle Stick Chart.

Here it comes.

A picture is worth a thousand words. Does not give us the clearest picture of market psychology? It does because it represents the market with color including closing price, opening price, the highest high and lowest low. Moreover, it shows us rejection or bounce (upper shadow/lower shadow) as well. Candlestick charting is one of the most important tools in modern days trading.

There are other things to be integrated with Candlestick Chart such as Support, Resistance, Fibonacci Levels, Pivot Points, Trend Line, and Channels, etc to be able to trade effectively. To be a long racehorse in trading, a trader must have a good understanding with all those. We will get more acquainted with Candlesticks, Candlestick Patterns and their usage, integration with other trading factors in our fore coming articles. Be with us. See you in our next article.

Categories
Forex Chart Basics

Dissection of a Candlestick

A candlestick is a type of price that financial markets’ charts use to display the high, low, opening, and closing prices for a particular period. It is the most commonly used price chart among financial traders nowadays. It does not only show the high, low, opening, and closing prices but also represents the true psychology of the traders. This is the main reason for the candlestick/candlestick chart being the most popular chart in the financial markets.

Let us demonstrate two typical types of candlesticks to find out how they look and how they are formed.

Let us start with a Bullish Candlestick.

In a Bullish Candlestick, the price opens at the downside; goes down and goes up again. This is what creates the lower shadow. The price continues to go upwards and goes all the way up to where the upper shadow ends. It comes down and closes at the Closing Price. This is what creates the Upper Shadow. Eventually, Opening Price and Closing Price creates Bullish Body. A Bullish Candlestick is usually represented by Green or White color.

Let’s have a look at a typical bullish market in Candlestick Chart.

The chart shows that the market is bullish. Most of the candles are bullish candlesticks. Thus the price heads towards the North. However, not all of them have Upper Shadow, Lower Shadow, or a thick Body that we have demonstrated in this lesson earlier. The market produces several types of Candlesticks, and they convey different messages to the traders.

A Bearish Candlestick is just the opposite. Let us have a look at that.

As we see here, that the price opens at the upside. Goes up and comes down to create the Upper Shadow. Comes all the way down and closes the price a bit further up. This is what creates the Lower Shadow. Difference between the Opening and Closing Price creates the Bearish Body.

Let us have a look at a bearish market in Candlestick Chart.

Same goes here. Not all the candlesticks are as typical as we have demonstrated in our lesson. However, the message is clear here. The price is bearish because of the dominance of Bearish Candles.

Not all the candles with a bearish body (or bullish body) declare the supremacy of the bearish market (or bullish market). By being able to read them well, traders can predict the market’s trend, trend continuation, and trend reversal.

In our fore coming articles, we will learn different types of candlesticks that the market produces; how they look like; what message they convey to the traders; how to read and make a profit out of them.

 

 

 

Categories
Forex Basics

Forex And The Importance Of Education

The Importance of Forex Trading Education

This is a growing market with an average daily turnover of US$5.3 trillion! That’s around £4 trillion. So who is taking advantage of this incredibly liquid market; the biggest traded business on the planet? Large companies and institutions including banks, HNW individuals, fund managers, firms that have overseas business activities all need to hedge their currency exposure, sovereign funds and central banks, and everyday people in their bedrooms are now trading Forex, thanks to the proliferation of the internet!

However, it is well known that 95% of new Forex traders will lose their money within 6 months. In fact, according to Reuters the China Banking Regulatory Commission banned banks from offering retail Forex on margin to their clients back in 2008. The writing was on the wall!

In 2014, the French regulator conducted a survey which concluded that the average % of losing clients was 89%, with clients who squandered €11K, on average, between 2009 and 2012. Over that 4 year period, 13,224 clients lost €175M.  The estimated number of losing retail traders across Europe during this period was €1 million.

In 2015 the US National Futures Association announced a reduction on limits that US brokers could offer their retail clients to a maximum of 50:1 in 10 listed major foreign currencies, and 20:1 on some others. Similarly, The European Securities and Markets Authority (ESMA) recently confirmed stricter changes to the way brokers are able to offer retail Forex clients leveraged trading. I expect we shall see a lot more of this type of intervention in years to come.

Yet none of this really addresses the real issue, which is why people, especially new traders, lose money trading Forex? It simply comes down to education. I wouldn’t strip a car engine down without first going to mechanic classes, or operate on a human without going to medical school, or fly a plane without lessons. And yet thousands of individuals think they can open an FX account and consistently make money. Sure, they might get lucky initially and think they are on a roll, before over leveraging themselves and wiping out their accounts.

In my opinion, if governments want to intervene, they need to address education. Of course, reducing leverage and insisting on larger margin requirement will slow down the rot. But it won’t stop it, whereas insisting that traders are qualified would have a much more positive impact in the long run. Just like any profession, people need to be fully educated and a basic level of Forex trading education should be the first thing undertaken before newbies are let loose ‘trading’, a term I use loosely, under the circumstances, they are gamblers, and we all know what happens to most gamblers!

So to all you people who are thinking about becoming a currency trader, invest in a professionally put together A-Z education course and at least give yourself a chance in this volatile arena, which is fraught with danger and will think nothing of absorbing your hard earned cash into its coffers!

Here at Forex.Academy we recognise this issue and feel passionately about it. What’s more, we offer all the educational tools you will need to trade effectively!

Categories
Forex Basics

Everything you should master to Detect Trends, and more!

Introduction

In chapter 1, we’ve set the foundations of market classification, what a trend is about, and the dissection of a trend in its several phases. Then we talked about its two dissimilar wave parts: an impulsive wave, followed by a corrective wave.  We dealt with support, resistance, and breakouts. Finally, we talked about channel contractions.

In this second chapter, we’ll learn the methods available in the early discovery of trends: Trendlines, moving averages, and Bollinger band channels.

Trendlines

A trendline is a line drawn touching two or more lows or highs of a bar or candlestick chart. The convention is to draw the line touching the lows if it’s an uptrend and the tops on a downtrend. Sometimes both are drawn to form a channel where the majority of prices fit.

As we see in Fig. 1 the trendline tends to draw resistance levels or supports where the price finds it difficult to cross, bouncing from there, although not always this happens. In Fig. 1 the first trendline has been crossed over by the price, and during the following bars, the slope of the downtrend diminished.  We saw, then, that the first trendline switched its role and now is acting as price support.

When the second trendline was crossed over by the price, a bottom has been created, and a new uptrend started. After a while trending up, we might note that we needed a second trend line to more accurately follow the new bottoms because the uptrend has sped up, and the first trendline is no longer able to track them.

Fig. 2 shows two channels made of trendlines, one descending and the other ascending. The trendline allows us to watch the volatility of the trend and the potential profit within the channel. The trend, as is depicted, has been drawn after it has been developing for a long lapse. Therefore, it’s drawn after the fact.  If we look at the descending channel, we observe that during the middle of the trend, the upper trendline doesn’t touch the price highs. So, this channel would look different at that stage of the chart.

I find more reliable the use of horizontal lines at support and resistance levels and breakouts/breakdowns at the end of a corrective wave. But, if we get a well-behaved trend, such as the second leg in fig 2, a channel might help us assess the channel profitability and assign better targets to our trades. If we use horizontal trendlines together with the trend channel (see Fig 2.b) it’s possible to better visualize profitable entry points and its targets, and, then, compute its reward to risk ratio.  The use of the Williams %R indicator (bottom graph) confirms entry and exit points.

Fig. 2b graph’s horizontal red lines show how resistance becomes the support in the next leg of a trend.

As a summary:

  • A trendline points at the direction of the trend and acts as a support or as a resistance, depending on the price trend direction.
  • If a second trendline is needed, we should pay attention if it shows acceleration or deceleration of the price movement.
  • If the price crosses over or crosses under the trendline, it may show a bottom or a top, and a trend change.
  • A trendline channel helps us assess the potential profitability and assign proper targets to our next trade.

Moving Averages (MA)

Note: At the end of this document, an Appendix discusses some basic statistical definitions, that may help with the formulas presented in this section, although reading it isn’t needed to understand this section.

Some centuries back, Karl Friedrich Gauss demonstrated that an average is the best estimator of random series.

Moving averages are used to smooth the price action. It acts as a low-pass filter, removing most of the fast changes in price, considered as noise. How smooth this pass filter behaves, is defined by its period. A moving average of 3 periods smoothens just three periods, while a 200-period moving average smoothens over the last 200 price values.

Usually, a Moving Average is calculated using the close of every bar, but there can be any other of the price points of a bar, or a weighted average of all price points.

Moving averages are computationally friendly. Thus, it’s easier to build a computerized algorithm using moving average crossovers than using trendlines.

Most Popular types of moving averages

Simple Moving Average(SMA):

The simple moving average is computed as the sum of all prices on the period and divided by the period.

The main issue with the SMA is its sudden change in value if a significant price movement is dropped off, especially if a short period has been chosen.

Average-modified method (AvgOff)

To avoid the drop-off problem of the SMA, the computation of an avgOff MA is made using and average-modified method:

Weighted moving average

The weighted moving average adds a different weight to every price point in the period of calculation before performing the summation. If all weights are 1, then we get the Simple Moving Average.

Since we divide by the sum of weights, they don’t need to add up to 1.

A usual form of weight distribution is such that recent prices receive more weight than former prices, so price importance is reduced as it becomes old.

w1 < w2 < w3… < wn

Weights may take any form, most popular being Triangular and exponential weighting.

To implement triangular weighting on a window of n periods, the weights increase linearly from 1 the central element (n/2), then decrease to the last element n.

Exponential weighting is an easy implementation:

EMAt = EMAt-1 + a x (pt Et-1)

Where a, the smoothing constant, is in the interval 0< a < 1

The smoothing property comes at a price:  MA’s lags price, the longer the period, the higher the lag of the average. The use of weighting factors helps reducing it. That’s the reason traders prefer exponential and weighted moving averages: Reducing the lag of the average is thought to improve the edge of entries and exits.

Fig 3 shows how the different flavors of a 30-period MA behave on a chart. We may observe that the front-weighted MA is the one with a slope very close to prices, Exponential MA is faster following price, but Triangular MA is the one with less fake price crosses, along with simple MA: The catch is: We need to test which fits better in our strategy. The experience tells that, sometimes, the simpler, the better.

Detecting the trend using a moving average is simple. We select the average period to be about half the period of the market cycle. Usually, a 30 day/bar MA is adequate for short-term swings.

One method to decide the trend direction is to consider it a bull leg if the bar close is above the moving average; and a bear leg if the close is below the average.

Another method is to watch the slope of the moving average as if it were a trendline. If it bends up, then it’s a bull trend, and if it turns down, it’s a bear trend.

A third method is to use two moving averages:   Fast-Slow (Fast -> smaller period).

In this case, there are two variations:

  1. Moving average crossovers
  2. All the averages are pointing in the same direction.

As with the case of a single MA, a price retracement that touches the slower average is an opportunity to add to the position.

For example, using a 30-10 MA crossover: If the fast MA crosses over the slow MA, we consider it bullish; if it crosses under, bearish.

Using the method of both MA’s pointing in the same direction, we avoid false signals when the fast MA crosses the slow one, but the slow MA keeps pointing up.

When using MA crossovers, we are forbidden to take short trades if the fast MA is above the slow MA, but we’re allowed to add to the position at price pullbacks. Likewise, we’re not allowed to trade on the buy side if the fast MA is below the slow MA.

Using smaller periods, for instance, 5-10 MA, it’s possible to enter and exit the impulsive legs of a trend.  Then, the 10-30MA crossovers are used to allow just one type of trade, depending on the trend direction, and the 5-10 MA crossover is actually used as signal entry and exit (if we don’t use targets). In bull trends, for example, we may enter with the 5MA crossing over the 10MA, and we exit when it crosses under.

Bollinger Band Channel

We already touched channels that were made of two trendlines. There is another computationally friendly channel type that allows early trend detection and trading.

One of my favorite channel types is using Bollinger Bands as a framework to guide me.

A Bollinger Band is a volatility channel and was developed by John Bollinger, which popularized the 20-period, 2 standard deviations (SD) band.

This standard Bollinger band has a centerline that is a simple moving average of the 20-period MA. Then an upper band is drawn that is 2 standard deviations from the mean and a lower band that’s 2 standard deviations below it.

I tend to use two or three 30-period Bollinger bands. The first band is one SD wide, and the second one is two SD apart from the mean. A third band using 3 standard deviations might be, also, useful.

Fig 6 shows a very contracted chart with 3 Bollinger bands to show how it looks and distinguishing periods of low volatility.

During bull trends, the price moves above the mean of the Bollinger band.  During bear markets, the price is below the average line of the bands.

On impulsive legs of a trend, the price goes above 1-SD (or below on downtrends), and it continues moving until it crosses the 2-SD line, sometimes it even crosses the third 3-SD line. Price beyond 2 SDs is a clear sign of overbought or oversold. On corrective legs, the price goes back to the mean. During those phases volatility contracts, and is an excellent place to enter at breakouts or breakdowns of the trading range.

Below Fig. 7 shows an amplified segment of Fig 6, with volatility contractions circled. We may observe, also, how price moves to the mean, after crossing the 2 and 3 std lines.

 

Grading your performance

According to Dr. Alexander Elder, the market is testing us every day. Only most traders don’t bother looking at their grades.

Channels help us grade the quality of our trades. To do it, you may use two trendlines or some other measure of the channel. If you don’t see one, expand the view of the chart.

When entering a trade, we should measure the height of the channel from the bottom to its top.  Let’s say it’s 100 pips.  Suppose you buy at ¾ of the upper bound and sell 10 pips later. If you take 10 pips out of 100 pips, your trade quality is 10/100 or 1/10. How does this qualify?

According to Elder’s classification, any trade that takes 30% or more of a channel is credited with an A. If you make between 20 and 30%, your grade will be B. Between 10 and 20% you’re given a C and a D if you make less than 10%.  So, in this case, your grade is C.

Good traders record their performance. Dr. Elder recommends adding a column for the height of the channel and another column for the percentage your trade took out of the channel.

Monitor your trades to see if your performance improves or deteriorated.  Check if it’s steady or erratic.  The information, together with the autopsy of your past trades, helps you spot where are your failures: Entries too late? Are you exiting too soon? Too much time on a losing or an underperforming trade?  A trade against the prevailing trend?

 

The next chapter will be dedicated to chart patterns.


 

Appendix: Statistics Overview

Statistics is a branch of mathematics that gives us information about a data set. Usually, the data set cannot be described by an analytical equation because they come from unpredictable or random events. As traders, we need basic knowledge, at least, of statistics for our job.

We can express statistical data numerically and graphically. Abraham de Moivre, back in the XVII century, observed that as the number of events (coin flips) increased, the shape of the binomial distribution approached a very smooth curve. De Moivre thought that if he could find the mathematical formula for this curve, he could solve problems such as the probability of 60 or more heads out of 100 coin flips. This he did, and the curve is called Normal distribution.

This distribution plays a significant role because of the fact that many natural events follow normal distribution shapes.  One of the first applications of this distribution was the error analysis of measurements made in astronomical observations, errors due to imperfect measuring instruments.

The same distribution was also discovered by Laplace in 1778 when he derived the central limit theorem. Laplace showed the central limit theorem holds even when the distribution is not normal and that the larger the sample, the closer its mean would be to the normal distribution.

It was Kark Friedrich Gauss, who derived the actual mathematical formula for the normal distribution. Therefore, now, Normal distribution is also named as Gaussian distribution.

Although prices don’t follow a normal distribution, it’s is used in finance to extract information from prices and trading statistics.

There are two main measures we use routinely: The center of our observations and the variability of the points in our data set from that mean.

There’s one main way to compute the center of a set: the mean. But it’s handy to know also the median if the distribution isn’t symmetrical.

Mean: It’s the average of a set of data. It’s computed adding all the elements of a set and divide by the number of elements:

Mean = Sum(p1-Pn)/n

Median: The median is the value located in the middle of a set after the set has been placed in ascending order. If the set has a symmetrical distribution, the median and the mean are the same or very close to it.

The variability of a data set may be calculated using different methods. Two main ways are used in financial markets:

Range: The easiest way to measure the variability. The range is the difference between the highest and lowest data of a set. On financial data, usually, a variant of the range is calculated: Average true range, which gives the average range over a time interval of the movement of prices.

Sample Variance(Var): Variance is a measure of the mean distance of the data points around its mean. It’s computed by first subtracting the average from all points: (xi-mean) and squaring this value. Then added together and dividing by n-1.

Var = 𝝈2 =∑ (x-mean)2 / (n-1),

whereis the symbol for the sum of all members of the set

By squaring (xi-mean), it takes out the negative sign from points smaller than the mean, so all errors add-up. The division by n-1 instead of n helps us not to be too much optimistic about the error. This measure increments the error measure on small samples, but as the samples increase, its result is closer and closer to a division by n.

If we take the square root of the variance, we obtain the standard deviation (𝝈 – sigma).

 Volatility: Volatility over a time period of a price series is computed by taking the annualized standard deviation of the logarithm of price returns multiplied by the square root of time expressed in days.

𝝈T = 𝝈annually √T

 


References:

New Systems and Methods 5th edition, Perry Kaufman

Trading with the Odds, Cynthia Kase

Come into my Trading Room, Alexander Elder

History of the Gaussian distribution http://onlinestatbook.com/2/normal_distribution/history_normal.html

https://en.wikipedia.org/wiki/Volatility_(finance)

Further readings:

Profitable Trading – Chapter 1: Market Anatomy

Profitable Trading Chapter III: Chart patterns

Profitable Trading – Computerised Studies I: DMI and ADX

Profitable Trading – Computerized Studies II: MACD

https://www.forex.academy/profitable-trading-computerized-studies-iii-psar/

Profitable Trading (VII) – Computerized Studies: Bands & Envelopes

Profitable Trading VIII – Computerized Studies V: Oscillators