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Crypto Daily Topic

Solving Blockchain’s Scaling Problem

Blockchain was conceptualized the first time in 2008 with the launch of Bitcoin. However, it took almost a decade to be fully appreciated as an invaluable public ledger with the potential to disrupt virtually every modern industry. That was the year when the price of Bitcoin got close to $19,900 from a low of $978 at the start of the year, and Ethereum went above $850 from just over $8. At its peak value, Bitcoin’s market cap stood at $320 billion – higher than the total value of all M3 UK currency in circulation. This was before the infamous 2018 cryptocurrency crash of January 2018.

Predictably, the massive cryptocurrency explosion was followed by a big crash, from which many cryptocurrencies that had successfully launched ICOs (Initial Coin Offerings) never recovered. During the preceding explosion, blockchain technology was hyped as the most revolutionary since the internet, and many industries started figuring how it could work for them. From transportation and health industries to banking and voting, the promises and claims that the new technology brought may have set people’s expectations a bit too high too fast.

While famous investors, economists, and even finance professionals warned that the rapid rise of the cryptocurrency prices was a bubble that would ultimately burst, a world driven by vague expectations and hunger for profit failed to listen. Most people read the most subtle signs they wanted to see – such as the listing of bitcoin futures by the Chicago Board Options Exchange (CBOE) and the Chicago Mercantile Exchange (CME) in December 2017 as a stamp of approval that Bitcoin and cryptos, in general, were ripe for investment.

Weaknesses of blockchain come to light

The rise in the popularity of blockchain and the rapid adoption of Bitcoin, Ethereum, and other cryptocurrencies brought blockchain’s most significant problem to light: it is expensive and can barely work on a large scale. When Bitcoin’s price soared to almost $20,000, its network quickly became overloaded, transactions took as long as a day to confirm, and transaction fees shot up to as much as $60 per transaction.

The world may not have been wrong to believe that blockchains presented a massive opportunity for the human race, but it was at this point that many started having doubts about whether Bitcoin was the currency of the future.

The blockchain technology was introduced to the world just at the right time when we were dealing with the aftermath of the 2008 financial crisis. However, in its current state, it cannot deliver on these promises on a global scale because it has one glaring weakness: it just cannot scale.

To see why this is such a concern, it is necessary to understand how blockchain works.

Blockchain is basically a list of ‘blocks’ of ordered data, in the case of cryptocurrency transactions, ‘chained’ together as a linked list. The blocks, once added to the chain, cannot be modified, which means that the list is add-only. There are specific rules that are followed before a block of data is added to the chain known as ‘consensus algorithm.’ In the case of Bitcoin, it is Proof-of-Work (PoW), while Ethereum is presently switching to Proof-of-Stake (PoS).

Due to this nature, blockchain has no single point of failure or control, its data cannot be altered, and the trail of changes made on the platform can be easily audited and verified. However, these benefits do come at a cost because blockchain is slow, and its immutable database has a very high redundancy rate. This is what makes it very expensive to use and virtually impossible to scale to a global scale.

Blockchain’s need to scale

The evolution of the entire blockchain ecosystem has been rapid over the past couple of years. The widespread implementation of blockchain systems for public use has been a significant vote of approval that the world is ready for it. However, the increasing adoption of these systems has brought to light the need for better design or alternatives.

The consequences of the increase in the number of daily transactions on a blockchain network have shown that block difficulty increases, thus increasing the average computational power required to mine a block of transactions. This translates to increased electricity consumption.

Another problem that prevents blockchain from scaling is that an increase in the number of transactions increases the size of the blockchain, making it harder to set up new nodes on the network to help in maintaining the complete blockchain network and to process and verify transactions. Therefore, the systems get not only slower and more expensive, but also unsustainable for such use cases as making regular small payments.

Potential solutions for blockchain scaling

There are numerous real-world uses of blockchain that have shown just how necessary the technology is for the future of humanity. Aside from payment processing and money transfer, it can also be used in monitoring supply chains, digital identification, digital voting, data sharing, tax regulation, and compliance, weapons tracking, and equity trading, among others.

One area that shows great promise and has accelerated the need for blockchain to scale is dApp or distributed apps that run on the blockchain network.

Over the past year, many developments have been proposed to resolve the platform’s scalability problems  – even implemented in some industries. So far, it shows great promise.

Here are some of the most sustainable ideas that blockchain platforms can implement to scale

☑️ Increasing the number of transactions in a block

A blockchain network would scale better when the number of transactions in a block is increased. This can be achieved by either increasing the block size or compressing individual transactions.

Bitcoin’s block size is limited to 1 megabyte. There was a lot of controversy in 2010 through 2015 on whether this size should be altered to accommodate more transactions to help the network scale.

Blockchains can also implement more efficient hashing algorithms that better compress the data to be added to the block. Algorithms that generate shorter signatures would go a long way to reduce the size of the block, and using better data structures to organize transactions may not only reduce the size of the block but also improve the privacy of its content.

☑️ Increasing the frequency in which blocks are added to the chain

The Bitcoin network adds a block of transactions every 10 minutes, while Ethereum does so in about 7 seconds. This duration is a function of the block difficulty level in a Proof-of-Work consensus. Since the frequency in which a new block is added to the chain significantly affects its transaction rate (TPS), reducing this time would significantly increase the network speed and reduce delays.

However, this rate of adding block cannot be arbitrary. Increasing the frequency would mean an increase in the block orphan rate (the rate at which mined blocks are not added to the blockchain due to competition) and an increase in the network bandwidth.

A change of such magnitude would require a hard fork of an existing blockchain platform. Since this is not backward compatible, it would not work for Bitcoin, Ethererum, or other established blockchain systems.

☑️ Implementing alternative communication layers between nodes

There is constant communication between nodes on a blockchain platform depending on the protocol it implements. For instance, in the Bitcoin network, transaction information is sent twice: the first time is in the broadcasting phase of the transaction, and then after the block is mined.

The Lightning Network is an excellent example of a second layer payment protocol that runs on top of the Bitcoin blockchain. It enables faster transaction speeds between nodes by opening a payment channel that commits funding transactions to the underlying layer without broadcasting to it until the final version of the transaction is executed. This is presently touted as the best solution to Bitcoin’s scalability problem.

☑️ Adopting better consensus and verification methods

At the time of writing this post, Ethereum is in the process of switching its consensus mechanism from Proof-of-Work (PoW) to Proof-of-Stake (PoS) to mitigate its scaling problem. Bitcoin uses the oldest yet most difficult to scale PoW. PoS is not only sustainable in power consumption but also results in higher block addition frequency to the blockchain and, ultimately, better scaling platforms.

Other than the blockchain consensus, a blockchain platform can scale better when better storage architecture that saves space is implemented. Blockchain takes up a lot of storage space because each node is required to have the whole blockchain state in order to verify new blocks. Since the size of the block increases with time, the platform would scale better if nodes could only store parts of the chain required to verify current blocks.

Bottom line

Different blockchain platforms have implemented various strategies in an effort to make their platforms scale better. The bottom line, however, remains that blockchain’s scalability problem persists as no solution has proven to be effective without compromising any of the top features that make blockchain a transparent, secure, and truly decentralized ledger system. However, considering how far the world has come in developing this new technology, we remain optimistic that there will come a solution that will finally make a global-wide blockchain system practical and seamless.

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Forex Basic Strategies Forex Daily Topic

The Case for Average True Range-based Stop-loss Settings

Most traders are taught to use stop-losses based on critical levels. The basic idea is to spot invalidation levels based on previous low or high. The assumption is that by putting the stop a few pips below or above a support/resistance level will be enough to ensure the right trade will not be stopped out and just bad trades will be taken away.

The problem with that is that all participants in the market, including institutional traders, can see these levels. Institutional traders have lots of cash to play with, so they can push the price down to take all the buy-stop (or sell-stop) orders they see in their price book.

Key-level-based Stops

In the following example, we see the EUR(USD making a breakout after failing to break the previous high, on high volume. A perfect setup for a short trade. We then see the price moving down and then retracing and heading up to our stop-loss. We have been cautious and set it above the last top made on the 6th of November.

Nevertheless, the price kept moving inexorably up until the stop was taken. This is market manipulation at the highest level by institutions. Institutions have advanced tools to observe the depth of the order book, so they know the place and amount of the stops. Also, they have the liquidity necessary to move up the market, take all the liquidity at excellent prices, then continue south.

Chart 1 – EURUSD Key-level-Based Stop-loss placement

 

ATR-Based stops

If we look at the next chart, we see the same asset with the Average True Range indicator added. For this kind of stop-setting strategy, we need to detect the short term range. Therefore, we use a period of five for the ATR indicator. Next, we look at the peak set by the latest impulsive candlestick, which happened ten bars ago, 0.00168, which is about 17 pips. This figure gives us the expected 4-hour price movement for the current market volatility. The usual is to protect us against two times this figure, at least. In this case, we would need to move the stop-loss level 34 pips away from the entry point.

Chart 1 – EURUSD ATR-Based Stop-loss placement

It is wise to keep statistics of the ideal ATR multiplier, because as the number increases, it cuts our position size for the same dollar-risk amount, and also it reduces our Reward-to-risk ratio.

John Sweeney developed the general method of stop-loss placement. He called it the Maximum Adverse Execution method. The theory of it has been already described in our article Maximum Adverse Excursion, so we are not going to repeat ourselves here. Using  MAE delivers statistical-significant and tamper-proof stops, but it is a bit cumbersome. The use of ATR Stops is a simpler and second-best option instead of the foreseeable key-level-based stops.

 

 

Categories
Crypto Videos

Bitcoin The Biggest Enemy Of Cryptocurrency Success

For the cryptocurrency skeptics

Ever since its inception over a decade ago, Bitcoin and the cryptocurrency market, in general, had quite a big group of skeptics declaring the market dead or directed towards obsolescence. Ten years later, Bitcoin is worth four figures, while the crypto sector as a whole is stabilizing and maturing.
However, cryptocurrencies still can’t seem to break into the mainstream and start getting used as they were intended. Very few merchants accept cryptocurrency payments, and even those that do immediately exchange their holdings to fiat currencies.

Argument against cryptocurrencies

There are currently several thousand cryptocurrencies on the market. This can be considered a sign of the success of the market as a whole. However, these numbers can be deceptive. According to a CNBC report, over 800 cryptocurrencies are essentially dead and worth less than a single penny. When we take those out, the vast majority are not relevant or popular. Not to mention reports of various scams and fraud that happened and are still happening in the ICO market.
Other cryptocurrencies aside, the chief troublemaker in the industry is, according to skeptics, none other than Bitcoin itself. After reaching stratospheric heights of $20,000 in December 2017, Bitcoin price started falling in January, which started a lengthy bear market. On top of that, the value of crypto transactions fell by nearly 75% during the second quarter of 2018 when compared to the first quarter.
This lack of acceptance, both in the investment and retail arena, can partially be attributed to the US SEC’s denial of over a dozen ETF filings. On top of it, the regulators are trying to protect their respective fiat currencies, which brings Bitcoin and the crypto market to another obstacle – regulation.


Argument for cryptocurrencies

While it is true that Bitcoin prices crashed in early 2018, the market seems to be maturing, and the volatility, which was one of the main problems, is gradually fading. While this is bad news for speculators, it is excellent news for both institutional and retail investors, as well as for people who want to use cryptocurrencies as a payment method.
Cryptocurrencies and blockchain technology, in general, are starting to receive more and more attention for their utility rather than price movements. While merchants still remain wary of cryptocurrencies, banks and other corporations already started employing them.
While many are advocating the idea that Bitcoin and the crypto market are mainstream, the sector is determined to prove them wrong. While cryptocurrencies may still not be a standard payment method, the technology, as well as the idea behind cryptocurrencies, is quickly becoming extremely popular in different sectors and industries. As companies continue to fix their problems by introducing their infrastructure to a new frictionless solution to old problems with blockchain, cryptocurrency will strive.


The Bottom Line

Even though the market is divided on whether the cryptocurrency market is going to fail or not, the market has continued to plug along and thrive. Although prices have fluctuated wildly, the sector is maturing and stabilizing.
As more companies discover uses for cryptocurrency and blockchain, and more users accept them as a way to simplify their lives, they will remain at a top spot when it comes to technological improvements. On top of that, at one point, if the concept gets fully adopted, we can expect cryptocurrencies to integrate itself in all ways of life. Coins and tokens may come and go as most projects are not resilient enough to survive the harsh market conditions. Still, the idea and the concept behind cryptocurrencies will undoubtedly thrive and get more respect as time passes.

Categories
Crypto Videos

How To Manage Your Cryptocurrency Assets – The Best Sources Available


Cryptocurrency asset management potential

As the internet became more and more popular, it started revolutionizing not only communication but online investing as well. By using the internet, many people could break down the informational and execution barriers that they were facing before. This brought an overwhelming amount of trading applications to the market. This gave an opportunity for a wider range of investors the ability to participate in financial markets with greater execution speed and reduced fees.


Cryptocurrency asset management

New milestones have been met as the UK-based robo-advisor, and online wealth manager Nutmeg surpassed GBP 1 billion in funds under management. On the other hand, such centralized execution and advice are used less in cryptocurrency trading. Cryptocurrency asset management tools are entering the market intending to assist retail investors that want to explore the market. Companies that create such tools have a clear incentive, which is to operate in a perspective market that started to stabilize.

Simplified cryptocurrency management

The process of purchasing cryptocurrencies is still harder than buying regular tradable equities, even in this day. As cryptocurrencies keep attracting new users, the need for straightforward tools designed to manage crypto portfolios is increasing.

Traditionally, new traders must first find a wallet that accepts the cryptocurrencies they wish to trade, and then find a way to buy that cryptocurrency. This is usually done via exchanges that require completing a multifaceted and lengthy verification process. Any form of diversification can mean using more than one wallet or exchange. While it is doable, this process is quite complex and presents a big barrier to entry for many new market participants.


As a result, companies are introducing a tool that was previously only used in traditional asset management, which will help people manage their cryptocurrency portfolios more easily. Instead of having to manage multiple accounts and wallets, cryptocurrency asset management platforms are there to help their users consolidate their diversified portfolios.
This concept is still rather new as most traders still manage their investments through their wallets. However, several platforms have established themselves on the market as asset management tools worth using.
Picking the right asset management tool
Even though the cryptocurrency market has an enormous number of exchanges active, the combination of cryptocurrencies they offer is not a comprehensive list. This poses a challenge for new investors, as exchanges are not compatible with all wallets, which can lead to certain complications when trying to manage a diverse array of assets.

Cryptocurrency asset management platforms

Seek to simplify the process without resorting to a third party to handle users’ investment. Some platform’s tools help its users manage multiple portfolios concurrently. On top of that, they allow for automatic syncing, so users’ trades and purchases will always be updated centrally.
Others provide more traditional asset management tools, such as allowing users to create their asset groups as well as combinations according to their liking and risk-aversion.


Centralization

One important thing to note is the centralized nature of these platforms. Most cryptocurrency asset management platforms are completely centralized, which means that the simplicity and ease of access is just one side of the coin.
Most of these platforms do not offer private keys to the “wallets” to their users, meaning that the funds are not under complete control of the users.

Simplicity is the key to success

Ultimately, the cryptocurrency market will only succeed if the barrier to enter the market is small or non-existent. Cryptocurrency asset management tools offer traders a simple and easy way to enter the market as well as manage their investments.

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Forex Course

25. Margin Terminologies – Balance & Rollover

In the previous lesson, we have understood the fundamentals of margin/leverage trading. In this lesson and the following few lessons, we shall be discussing different terms related to margin and margin account. And in this lesson, we will primarily talk about balance and also a brief description of the concept of rollover in Forex.

What is Balance?

Balance is the most basic term used in any type of account. Be it a regular savings account, a Demat account, or a margin account. The meaning of balance remains the same in the margin account as well, just like other account types.

Balance in a margin trading account is the amount of capital deposited by the user to his/her trading account. For example, if a trader deposits $1,000 to their margin trading account, then their balance would be equal to $1,000. This is the amount used for taking positions in the market. Apart from that, it is used up for other stuff as well, which will be discussed in the next sections of this article.

Another vital point to note here is that the balance amount is not affected when a trader enters a trade or when a position is open. The balance gets updated only after the trade is closed (rollover fee is an exception).

When does the balance gets affected?

The balance in a margin account is affected in the following ways:

  • When cash is deposited to the margin account.
  • When an open position is squared off (closed).
  • When open positions are kept overnight, so, though positions are open, funds will be debited from or credited to the margin account. And this fee is referred to as the rollover fee. 

What is Rollover in trading?

The concept of rollover is not a term that comes under a margin account. However, since this term is closely related to balance, it shall be discussed in this lesson.

As the name pretty much suggests, rollover is the process of shifting an open position from one trading day to another. This is a process that is done automatically by the brokers. As far as the internal working of rollover is concerned, the brokers close a position at the end of the trading day and simultaneously open a new position (at the closing price) the next trading day.

For this rollover to be done, brokers charge a fee called ‘swap.’ This is where the balance comes into the picture, as swap brings a change to the balance. Note that swap happens in both ways, i.e., it can be debited from as well as deposited to the user’s account balance. The interest rates of the currencies are the ones that determine if the swap is to be credited or debited. In simple words, If you are paid swap, the money will be credited to your account balance. Conversely, if you are charged swap, the money will be debited from your account balance.

This concludes the lesson on balance in a margin account. In the upcoming lesson, we shall be discussing two more terminologies related to Margin Trading. Don’t forget to take up the below quiz!

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Categories
Forex Harmonic Forex Trading Guides

Harmonic Pattern Guide – Walkthrough

 Harmonic Pattern – Walkthrough

Bearish Butterfly Pattern against 180-degree Square of 9 angle.
Bearish Butterfly Pattern against 180-degree Square of 9 angle.

The chart above is the AUDJPY Forex pair on its 6-hour chart. If you are unable to identify this pattern without referencing notes or the prior articles, you are not ready to use this form of technical analysis. Regardless, the pattern above is a Bearish Butterfly Pattern.

Harmonic Patterns are by there very nature indicative of imminent price reversals. The PRZ (Potential Reversal Zone) is, in my opinion, the most critical level when determining whether to utilize a Harmonic Pattern in my trading. A Harmonic Pattern itself is not a sufficient enough form of analysis to decide whether or not to take a trade. Harmonic Patterns, in my opinion, should not be used as a primary form of analysis, but rather a complementary or confirmatory form of analysis. The chart above is an excellent example of this.

The horizontal levels on AUDJPY’s chart are derived from W.D. Gann’s Square of 9 – natural number values that represent angles. The methods and theories in Gann Analysis are an entirely different topic and require years of study and research – but for this article, one component of his work will help make my point. The red horizontal line at the top is a 180-degree Square of 9 angle. The 180-degree Square of 9 angle is already a strong and naturally powerful level of resistance. When I see price is near the 180-degree Square of 9 angle, I know one thing is for sure:

There is a high probability that the AUDJPY will have difficulty crossing this level and a high probability of price, at least initially, being rejected from moving higher.

So I would naturally look to be taking a short trade if the market shows rejection at that level. That is where the presence of a Harmonic Pattern is desirable. The Bearish Butterfly Pattern is one of the most reliable and most powerful reversal patterns in all Scott Carney’s work. I know that the Butterfly Pattern typically shows up at the end of a swing – not necessarily a trend, but the end of a swing. If I see a Bearish Butterfly Pattern, I know one thing is for sure:

The Bearish Butterfly Pattern is a reversal pattern. I also understand that the Bearish Butterfly Pattern appears at the top of a swing, indicating an extended and overdone market.

After seeing price approach, the naturally strong reversal level of the 180-degree Square of 9 angle, and then the completion of a Bearish Butterfly Pattern, I believe that there is a sufficient amount of analysis to risk taking a short trade. A short trade is further validated by the completion of a bearish engulfing candlestick, as well as some lengthily bearish divergence on the RSI.

 

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Forex Harmonic Forex Trading Guides

Harmonic Patterns – Start Here

Harmonic Patterns – Start Here

Harmonic Patterns are an advanced form of analysis and require more than a basic understanding of the technical analysis of financial markets. For those of you who have familiarized yourself with the application of Fibonacci levels, Harmonic Pattern Analysis will, perhaps, be of use to you. The following is a list of the Harmonic Patterns available for learning here at Forex Academy. The suggested order of learning about these patterns is below.

Phase One – Basic Harmonic Patterns

AB = CD

The Gartley Pattern

Phase Two – Advanced Patterns

The Butterfly Pattern

The Bat Pattern

The Alternate Bat Pattern

The Crab Pattern

The Deep Crab Pattern

The Shark Pattern

The Cypher Pattern

The 5-0 Harmonic Pattern

Phase Three – Application

Harmonic Pattern Walkthrough

The article above provides an example of how to use Harmonic Patterns in your own analysis and trading.

 

 

Sources: Carney, S. M. (2010). Harmonic trading. Upper Saddle River, NJ: Financial Times/Prentice Hall Gartley, H. M. (2008). Profits in the stock market. Pomeroy, WA: Lambert-Gann Pesavento, L., & Jouflas, L. (2008). Trade what you see: how to profit from pattern recognition. Hoboken: Wiley

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Forex Course

22. Perks Of Trading The Forex Market

Introduction

The foreign exchange market is, no doubt, the most popular market in the world. Though it is considered to be a very risky business, it can prove to be the best platform for trading and investing if things are done wisely. People often are in a dilemma to choose between the stock market, commodity market, and the forex market. Hence, it is important to know the benefits each market has to offer. So, in this lesson, we shall discuss some significant benefits the forex market has to offer.

Advantages of Trading Forex

Open 24/5

The forex market is traded throughout the day from Monday to Friday. And this got to be the biggest advantage for the part-time traders. Since there are quite a large number of people who are into 9-5 jobs, the forex market is an excellent option as one can trade anytime during the day. Hence, the forex market is the most flexible market when it comes to timings.

Great Liquidity

The forex market is the largest market in the world. It has a huge volume of orders coming in every single second. With high liquidity, trades are executed as soon as the order is placed. In fact, the forex market has the highest liquidity compared to any other market.

Margin Trading

In forex, the retail traders get the facility to trade with leverage. That is, with leverage trading, a trader can trade with quantities even if they do not possess the required amount. This is a great advantage as it paves the way for the small traders who are willing to participate in the market.

Nominal Commission and Transaction Costs

Another significant benefit to consider about the forex market is that the forex brokers don’t really charge any high fee, such as brokerage fees, exchange fees, or clearing fees. Having said that, they do charge commission, which is in the form of spreads. The bid/ask price, which is often referred to as the transaction cost, is typically around 1% when the market conditions are normal.

The Freedom on Lot Sizes

In forex, the brokers allow trading with as low as 0.001 lots. And traders can choose from 0.01 lots, 0.1 lots and 1 lot. Hence, there are variable lot sizes in this market. But, if you were to consider the futures market, the lot sizes are of one type and are determined by the exchanges.

Free Demo Trading

Demo trading is one of the best features the forex brokers have to offer. And the cherry to the cake is that demo trading accounts are free of cost. Demo trading can be very helpful to both novice and professional traders. Novice traders can use it to get the hang of placing orders and other features in the platform, while professional traders can use them to test the consistency of their strategies. Hence, we can consider demo trading to be a powerful risk-reducing tool.

Facility to Go long and Go Short

In the forex market, there is no directional bias. This is because currencies are traded in pairs. If a trader thinks the base currency would rise in value, they can go long, and if they think it will depreciate in value, they can go short. So, unlike the stock market, a trader need not borrow shares to sell short an instrument. Hence, traders can profit from both rising markets as well as falling markets without any complications.

Hence, these were some of the most significant features and advantages of the forex market. In the coming lesson, let us put up a comparison between different markets and see which market proves to be the best; for now, take the below quiz and see if you have understood this lesson correctly.

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Forex Trading Guides

Ichimoku Kinko Hyo Guide – Start Here

Ichimoku Guide – Start Here

The Ichimoku Kinko Hyo system is a powerful, tested, and vetted trading system. This guide will lead you in the direction of the articles you should follow.

Phase One – Start Here

Ichimoku History

In this article, you will learn a short history of Japanese technical analysis. It is not necessary to read this article to understand the Ichimoku Kinko Hyo system, but I would suggest reading it.

Ichimoku Kinko Hyo System

Learn the Ichimoku Kinko System and its components. Learn how it works.

Phase Two – Beginners Strategies

Ichimoku Strategies

Ideal Ichimoku Strategy

Learn your first Ichimoku Strategy, the Ideal Ichimoku Strategy.

K-Cross Strategy

Learn the Kijun-Cross ‘Day Trading’ strategy.

Phase Three – Advanced Ichimoku Kinko Hyo Theory

The Two Clouds Discovery

Learn about Manesh Patel’s powerful discovery, an extremely useful addition to your Ichimoku trading strategies.

The Three Principles

Wave Principle

Price Principle

Time Principle

Learn about the three principles in Ichimoku Analysis. Ichimoku analysis has a Wave, Price, and Time principles.

 

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Forex Trading Guides Ichimoku

Ichimoku Kinko Hyo Guide – A walk through a trade.

Ichimoku Kinko Hyo Guide – A walk through a trade.

I want to preface this guide with a screenshot of my account.

Trade History
Trade History

The screenshot is a series of some of the trades I’ve made in early April 2019. I do this because this guide on trading with Ichimoku will target the trade that is highlighted. Additionally, I think it is important that if I am showing you an example of a trade for a guide, I should show that I had skin in the game. There are a great many guides and strategies that authors, analysts, and traders suggest, but few will share if they took the trade. The highlighted trade for the EURGBP is the trade I will be using for this guide. It is a great example of the trading methodology I use with the Ichimoku System.

 

Multiple Timeframe Analysis – Daily, 4-Hour, and 1-Hour

The Ichimoku Kinko Hyo system is most effective when utilizing multiple timeframes. It is the only way that I use the Ichimoku system. In my trading, I use the Daily, 4-hour, and 1-hour time frames. Multiple timeframes are extremely useful in filtering your trade entries and ensuring higher probability trade setups. The process below will go through the process I used to take the trade.

Step One – Daily Chart Check: Price greater than Kijun-Sen, NOT inside the Cloud.

Step One - Check Daily Cloud
Step One – Check Daily Cloud

The very first thing I check is the daily chart. If the price is inside the Cloud on the daily chart, I skip the chart. It’s dead to me. If the price is not inside the Cloud, I then look for where the price is in relation to the Kijun-Sen. The daily chart determines my trading direction. If the price is above the Kijun-Sen, I only take long trades. If the price is below the Kijun-Sen, I only take short trades.

Step Two – 4-Hour Chart Check: Price above the Cloud, Chikou Span above candlesticks.

Step Two - Check 4-hour chart.
Step Two – Check the 4-hour chart.

If the daily chart determines the direction of my trading, the 4-hour provides the filter for the entry chart (the 1-hour chart). The only things I am concerned about with the 4-hour chart is that the Chikou Span is above the candlesticks, and that price is above the Cloud. Preferably, the Chikou Span would also be in ‘open space’ – but I don’t use it as a hard rule. I have not found the open space to be as important during the change of a trend or corrective move.

(a note about ‘Open Space’ – Open Space is a condition where the Chikou Span won’t intercept any candlesticks over the next five to ten trading periods. When the Chikou Span is in open space, this represents ease of movement in the direction of the trend with little in the form of resistance (or support) ahead.)

The EURGBP trade we are analyzing is a good example of why, at the current position, I don’t consider the open space as strict as I would on the hourly. I want to refer you back to the daily chart. If, on the daily chart, both price and the Kijun-Sen are below the daily cloud, but price moves above the Kijun-Sen – I don’t consider the open space variable as important on the 4-hour chart.

Step Three – 1-Hour Chart Check

Step Three - 1-hour Entry
Step Three – 1-hour Entry

The 1-Hour chart is my entry chart. As long as Step One and Step Two are true, the 1-hour chart is where the bread and butter of the trading occurs. My entry rules are this:

  1. Future Span A is greater than Future Span B.
  2. Chikou Span above the candlesticks and in ‘open space’ – for five periods.
  3. Tenkan-Sen is greater than Kijun-Sen
  4. Price is greater than the Tenkan-Sen and Kijun-Sen.

I generally look for a profit target of 20-40 pips, depending on the FX pair. For example, on the NZDUSD, I would look for 20 pips, and on the GBPNZD, I would look for 40 pips. But there are some hard technical reasons to leave a trade before that profit target is hit. The list below represents my exit rules on the 1-hour Chart – I exit the trade if any of these conditions occur.

  1. Exit if Chikou Span below candlesticks for more than three consecutive candlesticks.
  2. Exit if price enters the 1-hour Cloud.
  3. Exit if Tenkan-Sen below the Kijun-Sen for more than five candlesticks.

Step Four – Reentry Rules

Step Four - Reentry
Step Four – Reentry

Entry rules are fine, but the problem isn’t always finding the entry. One of the hardest problems is creating rules for re-entering a trade. Mine are as follows:

  1. Tenkan-Sen and Kijun-Sen must be above the Cloud.
  2. Chikou Span above the candlesticks.
  3. Price greater than Kijun-Sen and Tenkan-Sen.

A quick summary of steps taken

  1. Checked the daily chart, the price was above the daily Kijun-Sen. The trade direction is long/buy.
  2. Check the 4-hour chart, the price was above the Cloud, and the Chikou Span was above the candlesticks.
  3. All 1-hour rules confirmed an entry; profit taken at 40 pips.
  4. Re-entered trade on 1-hour chart, exited when price entered the 1-hour Cloud.

 

Sources: Péloille, Karen. (2017). Trading with Ichimoku: a practical guide to low-risk Ichimoku strategies. Petersfield, Hampshire: Harriman House Ltd.

Patel, M. (2010). Trading with Ichimoku clouds: the essential guide to Ichimoku Kinko Hyo technical analysis. Hoboken, NJ: John Wiley & Sons.

Linton, D. (2010). Cloud charts: trading success with the Ichimoku Technique. London: Updata.

Elliot, N. (2012). Ichimoku charts: an introduction to Ichimoku Kinko Clouds. Petersfield, Hampshire: Harriman House Ltd.

 

Categories
Ichimoku

The Three Principles – Timespan Principle

The Three Principles – Timespan Principle

In another correlation to Western analysis, Hosada’s Ichimoku Kinko Hyo system has a timing component within the system. The numbering system used in Ichimoku is unique when compared to Western analysis. The reason for the numbering and counts in Ichimoku is related to the cultural importance of some numbers in Japan versus others. Numbers that would be considered ‘lucky’ in Japan are the same numbers in the West and many other cultures – particularly 7 and 9. But those numbers themselves are not what is important. How, exactly, this numbering and count system came to be developed in the fashion that it was developed I do not know. The following is directly from Ichimoku Chats – An Introduction to Ichimoku Kinko Clouds by Nicole Elliot – I heavily suggest getting her book (the 2nd edition). The important numbers are:

9, 17, 26, 33, 42, 65, 76, 129, 172, 257

If you ever study the work of WD Gann, then these numbers are not only familiar but non-random.

Numbering

Numbering the candlesticks in a pattern is done with traditional Arabic numbers (1,2,3,4,5, etc.) and English letters (A, B, C, D, E, etc.). When counting how many candles are in a trend/wave, the last candle in an uptrend is counted as the first in the down wave and vice versa. See below:

Timespan Principle - Candle Counts
Timespan Principle – Candle Counts

Notice that candle 19 is also A, candle H is also 1. Also, notice that the time counts (total number of candles) in this ‘N’ wave all represent essential numbers in the Ichimoku number system. 19 is close to 17, H is close to 9, and 8 is close to 9.

Kihon Suchi – ‘Day of the turn.’

Nicole Elliot’s work is fantastic – it’s refreshing to read an analyst and trader who updates her work and goes through the grueling process of keeping it relevant. Kijun Suchi (‘the day of the turn’). The Kihon Suchi is the Hosada’s Timespan Principle put into practice. It is very similar to the use of Gann’s cycles of the Inner Year or horizontal Point & Figure counts to identify turns in the markets. Let’s use the image above again as an example. Below, I’ve separated the ‘N’ wave into A, B, and C.

Timepsan Principle - Combined Counts
Timespan Principle – Combined Counts

When adding the number of bars in A, B, and C, we always subtract 1 from each wave after the first. For example, if we counted five waves and the total was 100 bars, we would subtract 4 from 100; 96. On the chart above, the total number of bars of A, B, and C is 33 bars. We subtract 2 from 33 to get 31. This is where the Timespan Principle using Kihon Suchi comes into play. We should be able to project the end of the down drive that will occur after wave C. Does it work? Let’s see.

Timespan Principle - A+B+C = D
Timespan Principle – A+B+C = D

Below is another example. In reality, the use of the Timespan Principle is a very simplified version of a phenomenon known as a foldback pattern. But Japanese analysis focuses on the quality of equilibrium, so it makes sense to see this kind of behavior from a method that focuses on balance in all things.

Timespan Principle - Symmetrical Inverse Head & Shoulder Pattern
Timespan Principle – Symmetrical Inverse Head & Shoulder Pattern

 

Sources: Péloille, Karen. (2017). Trading with Ichimoku: a practical guide to low-risk Ichimoku strategies. Petersfield, Hampshire: Harriman House Ltd.

Patel, M. (2010). Trading with Ichimoku clouds: the essential guide to Ichimoku Kinko Hyo technical analysis. Hoboken, NJ: John Wiley & Sons.

Linton, D. (2010). Cloud charts: trading success with the Ichimoku Technique. London: Updata.

Elliot, N. (2012). Ichimoku charts: an introduction to Ichimoku Kinko Clouds. Petersfield, Hampshire: Harriman House Ltd.

 

Categories
Ichimoku

The Three Principles – Price Principle

The Three Principles – Price Principle

This will be the shortest article over the three principles, mainly because it is the same as many other Western styles of price projection. I do not need to go into any significant detail here. If you want further detail into this method, I would suggest Nicole Elliot’s book, Ichimoku Charts – An Introduction to Ichimoku Kinko Clouds (2nd Edition).

Elliot identified four price target methods from Hosada’s work: V, N, E, and NT. Elliot does mention that she (myself included) does not use this analysis and relies instead on traditional Western methods. However, she does cite that for investors and traders with short time horizons that this Japanese method of the Price Principle is superior to many techniques.

 

V Price Target

V = B + (B – C)

Inverse: B – (B+C)

Price Principle - V Price Target
Price Principle – V Price Target

 

N Price Target

N = C + (B – A)

Inverse: C – (B + A)

Price Principle - N Price Target
Price Principle – N Price Target

 

E Price Target

E = B – (A – B)

Inverse E: B + (A + B)

Price Principle - E Price Target
Price Principle – E Price Target

 

NT Price Target

NT = C + (C – A)

Inverse NT: C – (C – A)

Price Principle - NT Price Target
Price Principle – NT Price Target

 

 

Sources: Péloille, Karen. (2017). Trading with Ichimoku: a practical guide to low-risk Ichimoku strategies. Petersfield, Hampshire: Harriman House Ltd.

Patel, M. (2010). Trading with Ichimoku clouds: the essential guide to Ichimoku Kinko Hyo technical analysis. Hoboken, NJ: John Wiley & Sons.

Linton, D. (2010). Cloud charts: trading success with the Ichimoku Technique. London: Updata.

Elliot, N. (2012). Ichimoku charts: an introduction to Ichimoku Kinko Clouds. Petersfield, Hampshire: Harriman House Ltd.

 

Categories
Ichimoku

The Three Principles – Wave Principle

A man named Hidenobu Sasaki brought Hosada’s Ichimoku system and the three principles to contemporary times. He worked for Citigroup in Japan when he published his 1996 book, Ichimoku Studies.

These three principles have shared characteristics of many various styles and theories in Western technical analysis. A couple of examples of those would be Elliot Wave Theory and Tom DeMark’s Sequential. I would encourage all readers to pick up Nicole Elliots 2nd edition of Ichimoku Charts – An introduction to Ichimoku Kinko Clouds. It is my opinion that her work is the most in-depth on these three principles – even though she reports she does not use them. I also do not use any of these three principles. Nonetheless, they are a component of the entire Ichimoku system.

Principle One – The Wave Principle

The Wave Principle is an enigma. It is both singular in its nature when compared to Western analysis but also very complimentary. Ichimoku is a very dynamic form of analysis with broad interpretation and flexibility available for the analyst/trader. Elliot Wave Theory is a very static form of analysis with strict rules that must be adhered too.

Much of these patterns are going to be very much the same patterns that new traders and analysts first discover when learning Western-style technical analysis. One of the more interesting elements of the Wave Principle is the naming of each pattern. I am not sure if it was Sasaki or Hosada who used English letters to identify the shapes of these patterns. Many of these patterns are self-explanatory and familiar.

One Wave – ‘I’ Wave

Wave One - 'I' Wave
Wave One – ‘I’ Wave

Called the ‘I’ Wave, it is a simple (probably overly simple) single wave. I would call it a trendline more than a wave, but that is what Hosada calls it.

Two Wave – ‘V’ Wave

Two Wave - 'V' Wave
Two Wave – ‘V’ Wave

The ‘V’ wave is one of the most common patterns in technical analysis, it’s one of the first patterns we learn, but it’s not a specific pattern that we learn by itself. The ‘V’ wave is part of the M or W structure that makes up the majority pattern theory in technical analysis.

Three Wave – ‘N’ Wave

Three Wave - 'N' Wave
Three Wave – ‘N’ Wave

Again, this is a common pattern that most of you are already familiar with. The ‘N’ wave pattern in Nicole Elliot’s book shows symmetrical waves – which is important because the ‘N’ wave is essentially an AB=CD pattern, one of the building blocks of Harmonic Patterns. It is also a perfect description of what an A-B-C corrective wave in Elliot Wave Theory looks like.

Five Wave – ‘P’ Wave and ‘Y’ Wave

Five Wave - 'P' Wave
Five Wave – ‘P’ Wave

The ‘P’ wave is essentially another name for a popular and powerful continuation pattern known as a pennant. ‘P’ waves can also represent ascending or descending triangles. You will also see them in Ending Diagonals in Elliot Wave Theory. The pattern should also be called a ‘b’ pattern because the inverse of the ‘P’ pattern, a bullish pennant, is a ‘b’ shaped pattern – a bearish pennant.

Five Wave - 'Y' Wave
Five Wave – ‘Y’ Wave

The ‘Y’ wave is probably more commonly referred to as a megaphone pattern, broadening top or broadening bottom.

Combined Patterns

Combined Waves
Combined Waves

Although it may not need to be said, charts will show multiple patterns at any given time. And due to the fractalized nature of technical analysis, patterns within patterns are normal.

Wave Counts

Wave Counts
Wave Counts

So this part is the one where it will either make little sense or no sense. If you are new to technical analysis and/or never learned Elliot Wave Theory, the wave count component of the wave principle will make little sense. If you know the Elliot Wave Theory, then the wave count component will make no sense. Waves in Ichimoku are measured by time – a very Gann based approach. Trends are either Long-term or Short-term with no delineation between whether it is a bull market or bear market. There is no limit to the number of waves that can exist in a Long-term trend, but Short-term trends must be in single, double, or triple waves. The Ichimoku wave count is similar and very different from how we measure wave counts in the Elliot Wave Theory. In Elliot Wave Theory, moves occur in either three (corrective) or five (impulse) waves.

 

Sources: Péloille, Karen. (2017). Trading with Ichimoku: a practical guide to low-risk Ichimoku strategies. Petersfield, Hampshire: Harriman House Ltd.

Patel, M. (2010). Trading with Ichimoku clouds: the essential guide to Ichimoku Kinko Hyo technical analysis. Hoboken, NJ: John Wiley & Sons.

Linton, D. (2010). Cloud charts: trading success with the Ichimoku Technique. London: Updata.

Elliot, N. (2012). Ichimoku charts: an introduction to Ichimoku Kinko Clouds. Petersfield, Hampshire: Harriman House Ltd.

 

Categories
Crypto Videos

How To Get Your Token Listed On An Exchange? – Can You Make Money From Doing So?

How to get your token listed on an exchange and when?

Tokens that are easily available to the public become more attractive to buyers. On top of that, many exchanges require projects to have a value-adding product to be listed. Therefore, the token listing brings external confirmation of a value-adding product as well as a product that is easily tradable.

This brings us to the conclusion that the success of an ICO project often lies in getting listed on an exchange. Some people even invest in ICOs simply to “flip” them if they know that the token is being listed on an exchange in a reasonable time frame.


Choosing an exchange

As history shows us, listing a token on an exchange can, on average, increase its value by 15% – 20%. However, infrastructure providers of crypto listings are also aware of this fact. That’s why listing an ICO on a known crypto exchange can cost up to $3million. To cover these astronomical fees, startups are spending money raised through an ICO instead of using the funds for developing their product. But what are these companies getting out of the process and how they pick the right exchange? With more than 500 exchanges to choose from today, it is not an easy decision.

Factors to consider when choosing the right exchange:

  • Safety
  • Exchange fee
  • Liquidity
  • Exchange customer support
  • Different payment options
  • Is the exchange beginner friendly?
  • Does it accept fiat currency?
  • Centralization

1. Safety factor

Choosing a safe exchange is clearly a “must do.” With all the security breaches that happened to various cryptocurrency exchanges over time, one must be very careful when picking the right one. Choosing a decentralized exchange will certainly be much safer than choosing a centralized one. However, that might bring other problems. With that said, everything needs to be balanced out, but safety is certainly one of the biggest factors when choosing the right exchange.

2. Exchange fees

Various exchanges have various fees. Depending on how many people support the project, how desired it is, and how “revolutionizing” the exchange thinks the project is, different cryptocurrency projects will get different offers. Most exchanges currently do not have a fixed listing price, but rather set their price based on various conditions. Choosing an exchange that fits the budget is certainly a goal, but not at the expense of safety and integrity.

3. Liquidity

Liquidity and volume measure how big an exchange actually is. The more liquid the exchange is, the more volume listed coins have on average. With the correlation between liquidity of the exchange and token liquidity being clear, we can safely assume that exchanges with more liquidity will be better for the token. However, they usually have bigger listing fees or higher standards in terms of coin development.

4. Exchange customer support

Exchanges are often rated by their users (both token projects and traders). Based on the reviews, both good and bad, a project should decide on whether the exchange is suitable for them or not. Getting honest and detailed reviews can be hard, but it is doable. Companies should not be afraid to approach already listed token projects to seek advice when it comes to a particular exchange.

5. Different payment options

Most exchanges have the same payment options but should be checked just in case. Centralized exchanges, on average, have a wider variety of payment options.
Even though all of the payment options should be considered, they should not be an important factor when choosing the right exchange.

6. User-friendliness of the exchange

Depending on the project’s target audience, this factor might be more or less important. However, having a user-friendly exchange for your token is always a good thing!

7. Fiat currency trading pairs

If a token gets listed on an exchange which also supports trading fiat currencies, it might rise in price much more. Those exchanges are usually more regulated, but also more reputable.
The fact that a particular exchange supports fiat currency trading should not be important to the project from any technical side, but it does bring additional integrity and a positive reputation.

8. Exchange centralization

Choosing a centralized or decentralized exchange can be a big thing. They both carry a lot of positives and negatives.
Overall, decentralized exchanges are safer, but are currently lacking in every other department. Even though they are the future, it might be better to (at least for now) stick with centralized exchanges due to higher liquidity and user-friendliness.


Listing timing

Lastly, we need to mention token listing timing. Many people tried to debate whether it matters when the token is listed or not. However, there is no debate that whenever cryptocurrencies are in a bearish market/trend, smaller altcoins perform worse on average. This is because of mass fear and people exiting their positions to save themselves from the potential downswings. Therefore, timing plays a big role when it comes to token listing.
There are no formulas or clear guidelines when it comes to proper timing, but the general rule is that the more bullish market looks, the better chance a token has to succeed as soon as it gets listed.

Conclusion

Choosing the right exchange for the project is by no means an easy task. However, each project has an enormous choice of exchanges, which will ultimately allow them to pick the most suitable exchange for their needs.

Categories
Ichimoku

Ichimoku – The Two Clouds Discovery

The Two Clouds Discovery

In Manesh Patel’s book, Trading with Ichimoku Cloud – The Essential Guide to Ichimoku Kinko Hyo Technical Analysis, he made a fantastic discovery. When I first read his work, I almost missed it. Whether he knows it or not, Mr. Patel made a discovery and an observation that his peers have not written about in their work. I call this the ‘Two Clouds Discovery.’ It’s one of those moments where you know you’ve probably been aware of this phenomena, but no one put words to it. It’s one of those things where you go, ‘huh, why didn’t I think of that?’ or ‘I can’t believe no one else noticed this.’

Two Clouds

The Two Clouds discovery puts a label on the component we already know: the Kumo (Cloud). The names we are giving to these two components are the Current Cloud and the Future Cloud. The Current Cloud is where price action is currently trading. The Future Cloud is the further point of Senkou Span A and Senkou Span B – so Future Senkou Span A and Future Senkou Span B. It’s important to think of it this way:

The Current Cloud is the average of the Tenkan-Sen and Kijun-Sen from 26 periods ago.

The Future Cloud is the current average of the Tenkan-Sen and Kijun-Sen.

And here is the main point and of the Two Clouds Discovery: When a significant trend change occurs, the Future Cloud is thin with both the current Senkou Span and Senkou Span B pointing in the direction of the Future Cloud.

The image below is Gold’s daily chart. Using the market replay feature in TradingView, I have used November 20th, 2018, as the starting point for this article. It’s important to remember what we are looking for: Current Senkou Span A and Current Senkou Span B pointing in the direction of Future Senkou Span B and Future Senkou Span A.

First, we look to see if the Future Cloud is thin. The thickness or thinness of the Cloud is going to be very subjective, but I believe most people can determine whether something is thick or thin based on the instrument they trade and the timeframe they are trading in. For Gold, this is a thin cloud.

Thin Future Cloud

Next, we want to see if the Current Senkou Span A and Current Senkou Span B are pointing in the direction of the Future Cloud – they are.

Current Senkou Span A and Current Senkou Span B

Now, let’s see what happens when we populate the screen with the price action that occurred after November 20th, 2018. What we should see if a significant trend change is occurring when both the Current Senkou Span A and Current Senkou Span B are pointing in the direction of a thin Future Cloud.

Bull Move

Go through any Daily or Weekly chart and find a thin Cloud and then utilize the market replay – odds are you will see what I have discovered: a high positive expectancy rate of markets trending strongly when price is trading near where the current Senkou Span A and current Senkou Span B are pointing towards the direction of a thin Future Cloud.

 

Sources: Péloille, Karen. (2017). Trading with Ichimoku: a practical guide to low-risk Ichimoku strategies. Petersfield, Hampshire: Harriman House Ltd.

Patel, M. (2010). Trading with Ichimoku clouds: the essential guide to Ichimoku Kinko Hyo technical analysis. Hoboken, NJ: John Wiley & Sons.

Linton, D. (2010). Cloud charts: trading success with the Ichimoku Technique. London: Updata.

Elliot, N. (2012). Ichimoku charts: an introduction to Ichimoku Kinko Clouds. Petersfield, Hampshire: Harriman House Ltd.

 

Categories
Forex Videos

Why You Will Never Be A Successful Forex Trader – Understanding Forex Position Sizing

Position Sizing

Position sizing is the technical size of a trade, or the monetary risk, that a trader is going to take in any given trade. Investors use position sizing to help determine how many units of a particular currency they can purchase, or sell, which helps to control risk and help maximize returns.
Let’s face it, some people might be prepared to go into a casino and put all of their available funds on black, or red, or odds or evens, or a select a number on the roulette wheel, or snake eyes on a throw of the dice, and then hope for the best! A few lucky punters might win occasionally. However, the house always wins in the end!

In Forex trading, we are unlike a casino, insofar as we use fundamental and technical analysis skills in order to try and stack the odds in our favor. We then utilize position sizing in order to maximize our winning potential and also to help to mitigate against the risk of losing trades. In other words, if we do suffer a few losses, we live to fight another day, unlike gamblers who put all their money on one roll of the dice.
Therefore, traders must put up an appropriate amount per trade, given their level of experience, the level of volatility in the market, and proportional to their account balance size. This is where most inexperienced traders go wrong; they simply use too much of their capital per trade, and as a result, when they have a couple of losing trades, they blow their accounts. Statistically speaking, over 70% of new retail forex traders will blow their accounts within the first six months. This, coupled with a lack of understanding of how the forex market works and a lack of understanding regarding leverage and margin requirements, is the account killer for new traders.

In order to be a successful Forex trader, they must learn how to apply the correct use of capital exposure per trade or position sizing. The three most important issues are 1: how much capital they wish to assign to each trade, 2: what is the trade risk associated with each trade, and 3: are they calculating position size accurately.
All of these issues come under effective risk management and are just as important as any other area in Forex trading, such as technical and fundamental analysis. If traders do not understand this, then everything else they know about the market is a waste of time! In Forex trading, every aspect must work together in unison, in order for a trader to consistently win trades. When it comes to trading, capital preservation is paramount to survival.

Example A


Let’s look at example A: Determining capital risk per trade This is typically a percentage of an account balance
The average percentage per trade risk for retail traders is 2%
Example: 2% risk of a $2,000 account balance is $40
Calculation: $2000 x 0.02 or 2% = monetary trade size risk
In this example, a trader could experience ten back-to-back losing trades or $40 and still have
80% of the capital intact.

It is extremely advisable that new traders adopt this very important position sizing risk strategy, in order to achieve longevity in their trading careers, especially in the early stages. Once a trader has a consistent winning methodology in place percentage risk per trade can be gradually increased above 2%. Traders are also advised to try and achieve a minimum of 2 to 1 win to loss ratio. This would mean that a trader should be looking to make a minimum of $80 per trade win while risking a $40 loss.

Example B

Let’s look at example B: Determining trade risk per trade
Is there an accurate assessment of the probability of a positive outcome?
Are there enough reasons in place to enter this trade?
Decisions must be made to determine precisely where to place a stop loss
Does the chart confirm a realistic possibility of your trade hitting a minimum profit based on the 2 to 1 win to loss ratio?
One area where new traders fall down is their failure to understand that when they trade in the Forex market, they trade on a per pip basis within exchange rate fluctuations. That is to say, that traders’ winnings and losses are calculated on the movements of pips. In Forex, trading pips are calculated from four places to the right of the decimal point.

Example C

Therefore in example C, if we bought 1 mini lot of the EURUSD pair at 1:1100, we would need to place our stop loss at 1.1060, which would give us an exposure of $40.
In keeping with our 2 to 1 win-loss ratio, we would put our take profit at 1.1180.

Example D

Let’s look at example D: Notional trade size.
In order to understand position sizing, traders also need to understand the notional size of a trade. In keeping with our earlier EURUSD trade example, when setting our trade size on our platform, we need to understand about lot sizes. Therefore when trading currencies, because we are trading on leverage, essentially when we trade one mini lot, we are effectively trading 10,000 units of the base currency of the particular pair.
And so in our example, we would be buying 10,000 units of Euros, as the base currency is always quoted first, and the counter currency is always quoted second.

Categories
Crypto Videos

How To Trade Crypto With A Small Balance – Cryptocurrency Margin Trading

What is cryptocurrency margin trading?

Margin trading is a way of trading assets where traders use funds provided by a third party. Margin accounts allow traders to trade with much bigger capital, which can, in turn, bring bigger profit. Margin trading allows its users to leverage their positions. Users get to borrow a certain multiple of their original assets, which essentially amplifies their trading results. Amplifying trading results makes margin trading interesting in low-volatility markets such as Forex markets. However, they have their place in cryptocurrency trading as well.


In traditional markets, the additional funds are provided by an investment broker, while cryptocurrency markets work by traders offering the funds. In return for their investment, they earn interest. Some cryptocurrency exchanges also provide margin funds by themselves to their users, but that is far less common.

How does margin trading work?

The first thing that has to happen in a margin trade is that the trader commits a percentage of the total order value. These funds are better known as the margin. Margin trading accounts are used to exploit the feature that is leveraged trading. Leverage is the ratio of borrowed funds compared to the margin. As an example, a $1,000 trade with 100:1 leverage requires a margin of $10.

Different trading platforms offer bigger or smaller leverage, based on their capabilities as well as the asset class they are trading. Stock markets usually trade with a 2:1 ratio, while Forex trading can have leveraged trading of up to 200:1. Cryptocurrency trading platforms offer trading of up to 100:1.
Margin trading offers its users the feature to open both long and short positions. A long position is a bet that the asset’s price will go up, while a short position is a bet that the asset’s price will fall. Trader’s assets act as collateral for the borrowed funds for the duration of the position. If the market moves against the position, brokers have the option to liquidate the position. Margin trading is riskier than regular trading due to the leverage it offers. Margin trading cryptocurrencies brings the risk even higher due to their inherent volatility.


Pros and cons of margin trading

If we talk about advantages, the most obvious one is the profit-making potential. Leveraged positions can quickly result in larger profits as a bigger relative value is traded in the position. Margin trading is also useful when diversifying, as traders have the option to open many positions with relatively insignificant capital. The last advantage is simply the ease of use. Margin traders don’t have to shift large amounts of funds to the margin account.
If we talk about the advantages, we have to talk about the disadvantages of margin trading. Leveraged positions can, if not properly managed, bankrupt an account in a matter of seconds. Overleveraged trading that goes against the position will quickly lead to the liquidation of the funds. It’s extremely important to exercise caution while trading with leverage. Any form of stop-loss is also advised.

Margin funding

Trading is a task that requires a lot of research, knowledge, and intuition. Many people do not have the skillset or the risk tolerance to engage in margin trading. However, they still want to make a profit off of the whole margin trading idea. The way for them to profit from leverage trading is margin funding. Some trading platforms and cryptocurrency exchanges offer an option for users to invest their money to fund the margin trades of other users. This process has a set interest rate, which is quite low. However, so is the risk associated with the investment.


Conclusion

Margin trading is a useful tool for risk-averse traders that want to amplify their profit-making potential. If used properly, this method of trading can have an amazing effect on the profit size. On top of that, users interested in diversifying should also look into margin trading.
However, this method of trading amplifies potential losses as well. The risk it inherently brings is not for everyone.

Categories
Forex Ichimoku strategies Ichimoku

Ichimoku Strategy #1 – The Ideal Ichimoku Strategy

The Ideal Ichimoku Strategy is the first strategy in my series over Ichimoku Kinko Hyo. There are two sides to a trade, and so there will be two different setups for long and short setups. This strategy comes from the phenomenal work of Manesh Patel in his book, Trading with Ichimoku Clouds: The essential guide to Ichimoku Kinko Hyo technical analysis. Buy it, don’t pirate.

Patel identified this strategy as the foundational strategy. Because it uses all of the components of the Ichimoku system, I believe that this is the strategy that people should be able to know so well, that they can glance at a chart and understand what is happening. You should see this strategy and be ready to trade it profitably before you transition into trying other Ichimoku strategy. If you don’t, you can run the risk of being disenfranchised with the system and believe that it is another trading system that doesn’t work.

Moving on to the other strategies without mastering this strategy first is very dangerous to your trading development and your understanding of the Ichimoku Kinko Hyo system.

Ideal Ichimoku Bullish Rules

  1. Price above the Cloud.
  2. Tenkan-Sen above Kijun-Sen.
  3. Chikou Span above the candlesticks.
  4. The Future Cloud is ‘green’ – Future Senkou Span A is above Future Senkou Span B.
  5. Price is not far from the Tenkan-Sen or Kijun-Sen
  6. Tenkan-Sen, Kijun-Sen, and Chikou Span should not be in a thick Cloud.
Bullish Ideal Ichimoku Strategy Entry
Bullish Ideal Ichimoku Strategy Entry

Ideal Ichimoku Bearish Rules

  1. Price below the Cloud.
  2. Tenkan-Sen below Kijun-Sen.
  3. Chikou Span below the candlesticks.
  4. The Future Cloud is ‘red’ – Future Senkou Span A is below Future Senkou Span B.
  5. Price is not far from the Tenkan-Sen or Kijun-Sen.
  6. Tenkan-Sen, Kijun-Sen, and Chikou Span should not be in a thick Cloud.
Bearish Ideal Ichimoku Strategy Entry
Bearish Ideal Ichimoku Strategy Entry

 

Sources: Péloille, Karen. (2017). Trading with Ichimoku: a practical guide to low-risk Ichimoku strategies. Petersfield, Hampshire: Harriman House Ltd.

Patel, M. (2010). Trading with Ichimoku clouds: the essential guide to Ichimoku Kinko Hyo technical analysis. Hoboken, NJ: John Wiley & Sons.

Linton, D. (2010). Cloud charts: trading success with the Ichimoku Technique. London: Updata.

Elliot, N. (2012). Ichimoku charts: an introduction to Ichimoku Kinko Clouds. Petersfield, Hampshire: Harriman House Ltd.

 

Categories
Ichimoku

Ichimoku Strategy #2 – K-Cross, The Day Trading Strategy

The Kijun-Sen Crossover (Crossunder) Strategy is the second in my series over Ichimoku Kinko Hyo. There are two trades setups provided for the long and short side of a market. This strategy also comes from Manesh Patel’s book, Trading with Ichimoku Clouds: The essential guide to Ichimoku Kinko Hyo technical analysis.

Patel called this the day-trading strategy. He warned that this trading strategy has the lowest risk factor out of all of his strategies. The positive expectancy rate is lower, and so being stopped out of trades is a normal consequence of this strategy. He also indicated that the win/loss ratio could be extremely high.

Kijun-Sen Cross Bullish Rules

  1. Price crosses above the Kijun-Sen.
  2. Tenkan-Sen greater than the Kijun-Sen.
    1. If the Tenkan-Sen is less than the Kijun-Sen, then the Tenkan-Sen should be pointing up while the Kijun-Sen is flat.
  3. Chikou Span in open space.
  4. Future Senkout Span B is flat or pointing up.
    1. If Future Senkou Span A is less than Future Senkou Span B, then Future Senkou Span A must be pointing up.
  5. Price, Tenkan-Sen, Kijun-Sen, and Chikou Span should not be in the Cloud. If they are, it should be a thick cloud.
  6. Price not far from the Tenkan-Sen or Kijun-Sen
  7. Optional: Future Cloud is not thick.
K-Cross Strategy Bullish Entry
K-Cross Strategy Bullish Entry

 

Kijun-Sen Cross Bearish Rules

  1. Prices cross below the Kijun-Sen.
  2. Tenkan-Sen less than the Kijun-Sen.
    1. If the Tenkan-Sen is less than the Kijun-Sen, then the Tenkan-Sen should be pointing up while the Kijun-Sen is flat.
  3. Chikou Span in open space.
  4. Future Senkou Span B is flat for pointing down.
    1. If Future Senkou Span A is greater than Future Senkou Span B, then Future Senkou Span A must be pointing down.
  5. Price, Tenkan-Sen, Kijun-Sen, and Chikou Span should not be in the Cloud. If they are, it should be a thick Cloud.
  6. Price not far from the Tenkan-Sen or Kijun-Sen
  7. Optional: Future Cloud is not thick.
K-Cross Strategy Bearish Entry
K-Cross Strategy Bearish Entry

 

Sources: Péloille Karen. (2017). Trading with Ichimoku: a practical guide to low-risk Ichimoku strategies. Petersfield, Hampshire: Harriman House Ltd.

Patel, M. (2010). Trading with Ichimoku clouds: the essential guide to Ichimoku Kinko Hyo technical analysis. Hoboken, NJ: John Wiley & Sons.

Linton, D. (2010). Cloud charts: trading success with the Ichimoku Technique. London: Updata.

Elliot, N. (2012). Ichimoku charts: an introduction to Ichimoku Kinko Clouds. Petersfield, Hampshire: Harriman House Ltd.

Categories
Ichimoku

The Ichimoku Kinko Hyo System

The Ichimoku Kinko Hyo System

When I use the Ichimoku Kinko System in my trading, I can look at a chart and immediately know whether a trade can be taken in less than a minute. Ichimoku means, at a glance. Use this system enough, and you will be able to glance at a market and know if a trade is viable or not. What is singularly fascinating about this trading system more than any other is that it encompasses nearly every element of Japanese and Technical Analysis in a single system with just five components. The system measures momentum, volatility, breadth, depth, and even incorporates things we associate with the later part of the 20th century Western analysts like ATR (average true range) and the Bollinger Squeeze (see Bollinger Bands by John Bollinger).

This lesson will be an introduction to the components of the Ichimoku Kinko Hyo system. While Ichimoku is often listed as an indicator in much charting software, it is not an indicator. It is a trading system. It is a trading system made up of 5 indicators.

 

Books you should own

I loathe the illegal dissemination and downloading of technical analysis literature. One of the significant deterrents for expert traders and analysts in our field from publishing their work is that it is to easily copied and pirated. Additionally, there is a substantial amount of incorrect, incomplete, and false information regarding the Ichimoku system. I am recommending that the books below be on your trading bookshelf. The authors are experts in the field of technical analysis and traders themselves. I am very grateful that they have risked the fruit of their labors from being stolen so that they can share their knowledge for a fair price in a medium that will last for many, many years.

Trading with Ichimoku: a practical guide to low-risk Ichimoku strategies. – Karen Peliolle

Trading with Ichimoku Cloud: the essential guide to Ichimoku Kinko Hyo technical analysis – Manesh Patel

Cloud Charts: trading success with the Ichimoku technique – David Linton

Ichimoku Charts: An introduction to Ichimoku Kinko Cloud – Nicole Elliot

 

The 5 Components that make up the Ichimoku system

Ichimoku Kinko Hyo system

You will more than likely observe that the system appears to made up of several moving averages. And you would be correct. While I a staunch opponent of the use of any moving average based trading system, the Ichimoku system is an exception. If you remember the first article in this series, I ended it by pointing out the importance of ‘balance’ and ‘equilibrium’ in Japanese technical analysis. This system is a pure form of equilibrium in a market. The moving averages that you will first learn about are the Tenkan-Sen and Kijun-Sen. These are not moving averages calculated using the close of a candlestick. Instead, these moving averages are calculated by determining the highest high and lowest low of a period and then dividing that number by two. The moving average then plots the average of that line. Equilibrium, balance, and the mean is a consistent behavior in this system.

A quick note regarding the nomenclature of this system: Depending on the charting software you are using, the labels for the components will be in Japanese or your native language. For traders utilizing the beginners trading software of TradingView, TradingView utilizes the non-Japanese labels. I will be using the Japanese names. I believe it is essential that you learn to use the Japanese titles for these five components.

  1. Tenkan-Sen (Turning Line or Conversion Line)
  2. Kijun-Sen (Standard Line or Base Line)
  3. Senkou Span A (Cloud Span A, Span A, or Span 1)
  4. Senkou Span B (Cloud Span B, Span B, Span 2)
  5. Chikou Span (Lagging Line or Lagging Span)

 

Tenkan-Sen (Conversion Line)

Tenkan-Sen

The first component of the Ichimoku Kinko system is the Tenkan-Sen. The Tenkan-Sen is the fastest and weakest line of the Ichimoku system. It is a 9-period moving average that is plotted by adding the highest high and lowest low of the last 9-periods and then dividing that number by two.

Key Points

  1. Price should not be very far away from the Tenkan-Sen.
  2. If price and the Tenkan-Sen are both moving close together (up or down), then this means there is little volatility, and the move may be very persistent. Do not trade against an instrument that is displaying this behavior.

 

Kijun-Sen (Base Line)

Kijun-Sen

The second component of the Ichimoku Kinko Hyo system is the Kijun-Sen. The Kijun-Sen represents medium-term movement and equilibrium. It is a 26-period moving average that is plotted by adding the highest high and lowest low of the last 26-periods and then dividing that number by two.

Key Points

  1. Many entry and exit signals are derived from the Kijun-Sen (Peliolle).
  2. Price should not be very far away from the Kijun-Sen
    1. Use an ATR x2 to gauge how far is ‘too far.’ (Patel)
    2. Ichimoku trader Jon Morgan suggests identifying what calls ‘max mean.’ This is done by recording the last 17 major highs and lows away from the Kijun-Sen, adding those values together, and then divide by 17. If price gets close to that number of pips/ticks/points away from the Kijun-Sen, it will more than likely snap back to the Kijun-Sen or range until the averages catch up. (Morgan)

The T-K Cross and the relationship of the Tenkan-Sen with the Kijun-Sen

The Tenkan-Sen and Kijun-Sen represent the market’s pulse. The Tenkan-Sen indicates price volatility and the strength of a given movement through its slope. The Kijun-Sen establishes levels upon which equilibrium occurs, calling back prices when a state of disequilibrium can no longer sustain itself. (Peliolle)

Key Points

  1. Crosses of the Tenkan-Sen and Kijun-Sen are not a signal.
  2. In Forex markets, Morgan suggests that crosses may be an essential signal but only on daily and higher charts (3-day, Weekly, Monthly, etc.). This is especially true if there has been a significant amount of time since the last T-K Cross occurred. It can be an early warning sign of an impending corrective move or trend change. (Morgan)
TKCross

The chart above is the hourly chart for GBPJPY. The black vertical lines delineate a test period that records when the Tenkan-Sen crosses the Kijun-Sen. You can see how many whipsaws and trades you would have taken (136 to be exact). Compare that to the daily chart below and how important T-K crosses are when there is a significant gap between the last cross.

Daily TK Cross

You can see that the difference in time between these two crosses is significant. From the Tenkan-Sen crossing below the Kijun-Sen on March 27th, 2019, it took 162 calendar days before the Tenkan-Sen crossed above the Kijun-Sen on September 6th, 2019.

 

The Kumo (Cloud) – Senkou Span A and Senkou Span B

The Cloud – Senkou Span A and Senkou Span B

The Kumo (Cloud) is made up of the third and fourth components of the Ichimoku Kinko Hyo system, Senkou Span A and Senkou Span B. The ‘Cloud’ is the most distinguishing feature of the Ichimoku system. This ‘blob’ of color on the screen is perhaps one of the most ingenious applications of technical analysis theory in all of Technical Analysis. I say this because it is one of the very few forms of Technical Analysis that actively projects non-trend line-based data into the future – essentially turning lagging analysis into leading analysis. The Cloud is nothing more than the space between the two averages of Senkou Span A and Senkou Span B. Most software will then shade the area between these zones to correlate to the position of Senkou Span A to Senkou Span B. If Senkou Span A is above Senkou Span B, space is shaded green. If Senkou Span A is below Senkou Span B, the area is shaded red. The Cloud’s construction and interpretation is one that can cause significant confusion for someone new to this system, so I am going to break it down for each level.

Senkou Span A is the ‘faster’ line and is a measure of market balance and past volatility. (Peliolle) Senkou Span A is plotted by taking the average of the Tenkan-Sen and Kijun-Sen (Tenkan-Sen + Kijun-Sen) and dividing that number by two. It is then projected forward 26 periods.

Senkou Span B is the most powerful support and resistance level in the Ichimoku Kinko Hyo system. Senkou Span B is plotted by taking adding the highest high and lowest low of the last 52-periods, dividing that number by two, and then projecting it forward 26 periods.

Key Points

  1. A flat Senkou Span B represents strength.
  2. Thick Clouds equal strength. Thick Clouds also represent consolidation. (Linton)
    1. Thick Clouds tell us when not to trade. If you see price inside the Cloud, move on to another chart! (Morgan)
  3. Kumo Twists (Senkou Span A crossing Senkou Span B) are indicative of likely changes. Sometimes a Kumo Twist is the most immediately visible sign of a trend change. (Linton)
  4. The Cloud represents volatility.

 

The First Question You Should Ask Yourself

Price inside the Cloud

When using the Ichimoku Kinko Hyo system, the first question you should ask yourself is this: Is price inside the Cloud? If the answer is yes, then ignore that chart. Leave it alone. Find something else to do, find another chart to look at. That chart is dead to you if the price is inside the Cloud.

 

The Chikou Span (Lagging Span)

The fifth and final component of the Ichimoku Kinko Hyo system is the Chikou Span. I believe that this is the secret weapon of the entire system. If you have taken any classes or watched videos of the Ichimoku system anywhere else, the author or presenter may have removed the Chikou Span. I’ve read and observed a shocking number of people disregard the Chikou Span and treat it like it’s some pointless component that is not needed. People treat like it’s the gallbladder and just cut it out and think everything’s going to be just fine. That is a horrible idea.

This is my favorite tool in the entire system. It is very, very simple, and requires no averaging. It is merely the current price action shifted back 26 periods. It’s like a mirror image of the current price action. Even though it is simple to understand, visualizing this line can be hard. Look at the image below.

Chikou Span

The image above shows the Chikou Span on a Japanese Candlestick chart. If you are new to this trading system, you still may have a hard time ‘visualizing’ what the Chikou Span looks like. I think the easiest way for people to finally get it and experience the ‘ah-ha’ moment is to change the chart from a candlestick chart to a line chart. See below.

Candlesticks to Line Chart

When we change from a candlestick chart to a line chart, it is much easier to grasp and visualize what the Chikou Span is – because it is straightforward. The Chikou Span is just our current price shifted back 26 periods.

The Chikou Span represents the market’s memory. (Peliolle) It represents momentum. (Patel) David Linton identified what I consider one of the most crucial signals that can be generated on an Ichimoku chart. He wrote: When the Chikou Span crosses above or below the Cloud, it is THE confirmation signal in Ichimoku Analysis. (Linton)

Key Points

  1. Look for when the Chikou Span is in ‘Open Space.’ Manesh Patel identified Open Space as a condition when the Chikou Span won’t intercept any candlesticks over the next 5 to 10 periods. This indicates a much easier move for the price with almost no supportive/resistive structure to stop price.
  2. If the Chikou Span is trading ‘inside’ the candlesticks, the market is beginning to consolidate.
  3. The Chikou Span responds to the same support and resistance levels as the price does. (Peliolle)

 

Why 9, 26, and 52?

One of the biggest questions people will ask is, why does the Ichimoku system utilize the periods of 9, 26, and 52? Much of this has to do with history and Japan’s normal trading week. A trading week in Japan was six days, so 9 is 1.5 weeks. (Elliot). There are roughly 26 trading sessions in a month. (Elliot) 52 is approximately two full trading months. Do not change these values.

Let me repeat that.

Do. Not. Change. Those. Values.

You can change your timeframes all you want but never change the base Ichimoku settings. You will read people give reasons why you should do it for this market and that market. You will read reasons why using Western values is useful for Western traders. You will hear a myriad of reasons why you should change the base values. Don’t. The Ichimoku Kinko Hyo system is a time tested, proven profitable, and robust trading system. Don’t muck it up by introducing variables that are not a part of the system.

The following articles in the Ichimoku series will detail advanced Ichimoku concepts such as Hidenobu Sasaki’s Three Principles as well as trading strategies utilizing the Ichimoku system.

 


Sources: Péloille Karen. (2017). Trading with Ichimoku: a practical guide to low-risk Ichimoku strategies. Petersfield, Hampshire: Harriman House Ltd.

Patel, M. (2010). Trading with Ichimoku clouds: the essential guide to Ichimoku Kinko Hyo technical analysis. Hoboken, NJ: John Wiley & Sons.

Linton, D. (2010). Cloud charts: trading success with the Ichimoku technique. London: Updata.

Elliot, N. (2012). Ichimoku charts: an introduction to Ichimoku Kinko Clouds. Petersfield, Hampshire: Harriman House Ltd.

Categories
Ichimoku

Ichimoku Kinko Hyo – Introduction and History

Ichimoku Kinko Hyo

 

Ichimoku is not an indicator (many platforms incorrectly label it an indicator) – it is a trading system. Ichimoku Kinko Hyo is, in my opinion, the most effective trading system to use with Japanese Candlesticks.

The reasons for this require a deep dive into the fundamentals behind the differences of Japanese VS Western analysis – but that is for another article. The Ichimoku system – and it is a system, not an indicator – is perhaps the most complimentary system that you could ever use with Japanese candlesticks. The reasons for this are rooted in history.

 

History of Japan: Edo, Meiji, and Candlesticks

One of the most important and famous economists in history, Milton Freidman, often used a specific point in Japan’s history to show how powerful free markets are. This period was known as the Meiji Restoration. If you are unaware of this period of history, you should do a little reading. It’s an astounding story. The period we are most interested in is the period after the end of the Tokugawa Shogunate (Edo Period) and the beginning of the Meiji Period.

It’s important to understand that before the Restoration, Japan was militantly xenophobic. For over a quarter of millennia, no foreigners were allowed in Japan, and no Japanese were allowed to leave. This policy ended almost literally overnight when the Emperor opened the doors of Japan to foreign capital, industry, and ideas. In just a couple of decades, the Japanese went from mostly medieval technology to fast-forwarding their technology ahead almost 350 years. I mean, think about it. In 80 years, the people went from medieval plowshares to aircraft carriers. It’s truly fascinating. But the major transition wasn’t just the technological leap; it was the capital and market-based leap as well.

Believe it or not, Japan created the first futures exchange. The Dojima Rice Exchange was created in 1697 by samurai. Samurai were not just masterful warriors, but they had various duties throughout their existence – one of which was collecting taxes. Rice was the de facto currency in Japan for centuries – it’s how people paid taxes. Rice coupons were issued and used as the first futures contracts.

Fast forward to the end part of the Edo period; we have the first instance of what we now know as Japanese Candlesticks coming to use. Munehisa Homma (nicknamed Sakata) is credited with creating Japanese Candlesticks. It is important to note that Japanese Candlesticks (the mid-1700s) were used well before the invention of American Bar Charts (1880s). More on the history of Japanese Candlesticks and Mr. Homma’s invention will be discussed in another article.

 

Ichimoku Kinko Hyo History

The man who created Ichimoku is Goichi Hosada. David Linton’s book, Cloud Charts – Trading Success with the Ichimoku Technique and Nicole Elliot’s book, Ichimoku Charts – An Introduction to Ichimoku Kinko Clouds provide an excellent history of both Japanese candlesticks and Goichi Hosada’s time spent creating Ichimoku. Both of those books should be on your shelves!

The translation for Ichimoku Kinko Hyo is this: At a glance (Ichimoku), Balance (Kinko), and Bar Chart (Hyo). The most important word here, Kinko, for balance. Experienced traders in Japanese theory and pedagogy will know that one of the most important characteristics in Japanese technical analysis is the focus of balance and equilibrium. This trait is constant in the Ichimoku system. The focus of equilibrium and balance is constant in various Japanese chart forms as well (Heiken-Ashi and Renko). The concept of balance will make more sense when you learn the Ichimoku system in the next article.

 


Sources: Péloille Karen. (2017). Trading with Ichimoku: a practical guide to low-risk Ichimoku strategies. Petersfield, Hampshire: Harriman House Ltd.

Patel, M. (2010). Trading with Ichimoku clouds: the essential guide to Ichimoku Kinko Hyo technical analysis. Hoboken, NJ: John Wiley & Sons.

Linton, D. (2010). Cloud charts: trading success with the Ichimoku technique. London: Updata.

Elliot, N. (2012). Ichimoku charts: an introduction to Ichimoku Kinko Clouds. Petersfield, Hampshire: Harriman House Ltd.

Categories
Forex Course

13. General Myths In The Forex Market Every Trader Must Be Aware Of

Introduction

Forex is the market for trading currency pairs. It is a real business that happens over the internet. However, many new traders do not take it seriously and often associate it with gambling. And this misconception still exists in the minds of people. Hence, it is necessary to fade these thoughts away as it could lead to significant losses in the long term.

Having that said, in this lesson, we shall discuss some of the myths and facts about the forex market, which are vital for traders to know.

Myths about the Forex Market

Forex is a get-rich-quick scheme

Many traders enter into this market with the assumption that they can make quick profits consistently. They start off with a small capital do make quite a good amount of money. This entices them, and they begin to maximize their lot sizes. In the end, they lose all of their profits, including their capital in just one trade. So, do not ever enter the forex market, considering it to be a game of gambling as it can completely blow away your account within no time.

Professional traders have an accuracy of 100% profitability

Whosoever be the trader, when they trade in the forex market, it is almost impossible to have only profitable trades. This is because; sometimes, there are events that happen to occur without the knowledge of the trader. And during these times, there is a high probability for the trade to go against your direction. So, the consistency of a successful trader is around 80-90%.

Stop-losses are purposefully triggered by the broker

Many traders believe that their stop-losses are hunted by their broker. But, this is just a misconception in the minds of people. Note that brokers have absolutely nothing to do with your stop-loss. It is the market itself that hunts for your stop-loss.

There exists ‘THE best strategy’ in trading

Many novice traders, in fact, all novice traders, go in search of the best strategy to trade. But, the truth is that the best strategy is not an absolute term. There are a countless number of strategies out there, and it all depends on you on how you adapt to it. Hence, there the concept of  ‘best strategy’ is just a myth.

You need to have a financial degree to trade in forex

Well, a great fact to know about the forex market is that you do not need any degree to qualify to trade. However, as we always say, education is definitely required for you to succeed in the market even though it is not a formal one.

The price movements in the forex market are entirely random

Even though the forex market is extremely hard to predict, the price movements are not entirely random. There are different ways through which a trader can assess the conditions of these prices. With the help of Technical Analysis or statistical (quant) methods, a trader can moderately anticipate the price action of currency pairs and thereby they can have an edge in the market.

This brings us to the end of this lesson. We hope we’ve cleared out some of the misconceptions you had about the forex market. To have a recap to this lesson, we have a quiz set up for you below.

[wp_quiz id=”46291″]
Categories
Forex Harmonic

The 5-0 Harmonic Pattern

Harmonic Pattern Example: Bearish 5-0 Harmonic Pattern

The 5-0 Harmonic Pattern

Like the Shark Pattern, the 5-0 pattern is a relatively new pattern discovered by the great Scott Carney. Carney revealed this pattern in his second book in his harmonic series, Harmonic Trading: Volume Two.

The 5-0 pattern is easily one of the wonkiest looking patterns. Depending on where you are at with your knowledge of harmonic patterns, the 5-0 will look foreign. And this is primarily because the 5-0 Pattern starts a 0. If you are used to seeing XABCD,  then 0XABCD will undoubtedly look odd.

5-0 Elements

  1. The pattern begins (begins with 0) at the beginning of an extended price move (direct quote from Carney’s work).
  2. After 0 has been established, an impulse reversal at X, A, and B must possess a 113 – 161.8% extension.
  3. The projection off of AB has a 161.8% extension requirement to C. C can move beyond the 161.8% extension but not beyond 224%.
  4. D is the 50% retracement of BC and is equal to AB (a Reciprocal AB=CD Pattern).
  5. The reciprocal AB=CD is required.

One of the best ways to interpret this pattern is to view it from an exasperated trader’s point of view. If we take the Bullish 5-0 Pattern as an example, then we can see why. The AB leg ends with B below X, creating a lower low. We then get an extended move in time where the BC leg is the most prolonged move with C ending above A. The movement from B to C may take on the appearance of a bear flag or bearish pennant. C to D shows intense shorting pressure and a belief among bears that new lows are going to be found. Instead, we get to D – the 50% retracement of BC. Instead of new lower lows, we get a confirmation swing creating a higher low. That move will more than likely generate a brand new trend reversal or significant corrective move.

 

Sources: Carney, S. M. (2010). Harmonic trading. Upper Saddle River, NJ: Financial Times/Prentice Hall.  Gilmore, B. T. (2000). Geometry of markets. Greenville, SC: Traders Press.  Pesavento, L., & Jouflas, L. (2008). Trade what you see: how to profit from pattern recognition. Hoboken: Wiley.

Categories
Forex Harmonic

The Deep Crab Pattern

Harmonic Pattern Example: Bearish Deep Crab

The Deep Crab Pattern    

The Deep Crab is a variant of the regular Crab pattern. It is still a 5-point extension, and it still has the endpoint (D) at the 161.8% extension of XA, but the AB=CD importance is a little different.

The most distinguishing component of this pattern is the importance of the specific 88.6% retracement point of B. Along with the Crab Pattern, the Deep Crab Pattern presents an especially extended and long move towards D.

Carney stressed that the Crab and Deep Crab represent significant overbought and oversold conditions, and reaction after completion is often sharp and quick. It is the opinion of many traders and analysts that the Crab Pattern and Deep Crab represent some of the fastest and profitable patterns out of all harmonic patterns.

Deep Crab differences from the Crab

  1. BC leg projection is not as extreme as the Crab.
  2. B must be at least an 88.6% retracement. Common to move more than 88.6% retracement level not above/below X (not above X in a Bearish Deep Crab and not below X in a Bullish Deep Crab).
  3. AB=CD pattern variations are more important in the Deep Crab Pattern.
  4. The BC leg is a minimum of 224% but can extend to 361.8%.

Sources: Carney, S. M. (2010). Harmonic trading. Upper Saddle River, NJ: Financial Times/Prentice Hall.  Gilmore, B. T. (2000). Geometry of markets. Greenville, SC: Traders Press.  Pesavento, L., & Jouflas, L. (2008). Trade what you see: how to profit from pattern recognition. Hoboken: Wiley.

Categories
Forex Harmonic

The Shark Pattern

Harmonic Pattern Example: Bearish Shark

The Shark Pattern

The Shark Pattern is the newest harmonic pattern from Carney’s work (2016). He revealed this pattern in his third book in his Harmonic Trading series, Harmonic Trading: Volume Three.

To gain a further understanding of the terminology used in this article, I would strongly encourage everyone to pick up all three of Carney’s books.

The Shark Pattern shares some of the more peculiar conditions that exist on some of the most extreme patterns. For example, both the 5-0 and the Shark Pattern are not typical M-shaped or W-shaped patterns. The Shark Pattern shows up before the 5-0 Pattern. It also shares a specific and precise Fibonacci level that the Deep Crab shares: The 88.6% retracement.

One behavior that might sound abnormal to all other harmonic patterns is that the reaction to the completion of this pattern is very short-lived. I think this is one of the most potent harmonic setups in Carney’s entire work because I am an intraday trader, and this pattern is very much for active traders.

Shark Pattern Elements

  1. AB extension of 0X must be at least 113% but not exceed 161.8%.
  2. BC extends beyond 0 by 113% of X0.
  3. BC extension of AX must be at least 161.8% but not exceed 224%.
  4. Because the Shark precedes the 5-0 Pattern, the profit target should be limited to the critical 5-0 Fibonacci level of 50%.

 

Sources: Carney, S. M. (2010). Harmonic trading. Upper Saddle River, NJ: Financial Times/Prentice Hall.  Gilmore, B. T. (2000). Geometry of markets. Greenville, SC: Traders Press.  Pesavento, L., & Jouflas, L. (2008). Trade what you see: how to profit from pattern recognition. Hoboken: Wiley.

Categories
Forex Harmonic

The Cypher Pattern

The Cypher Pattern

The Cypher Pattern is another type of Harmonic Pattern – except it isn’t – but it is. This is one of the few patterns not identified by Scott Carney. Darren Oglesbee discovered this particular pattern.

This pattern is very similar to the Butterfly in both it’s construction and where it typically will occur (near the end of trends). However, the Cypher Pattern is a rare pattern and not one that shows up with a high amount of frequency. Don’t confuse rarity with being more powerful or profitable. I do not know enough about this pattern, nor have I had the opportunity to trade it enough to gauge it’s ‘power’ versus its peers. All I do know is that in the times I have traded it, its positive expectancy rate is high, no different than a Bat or Alternative Bat in my experience. The same goes for the Crab and Deep Crab, for that matter. Just like all of the other Harmonic Patterns that you will have learned about, the Cypher has specific rules and conditions that must be met for it to be a specified Cypher pattern.

Cypher Confirmation Conditions

  1. B must retrace to an expansive range between 38.2% and 61.8% of XA. At least 38.2% but not exceeding 61.8%
  2. C is an extension leg and moves beyond A – but must move to at least 127.2%, but it is normal for it to go as far as the 113% – 141.4%. It is considered invalid if it moves beyond the 141.4%
  3. CD leg should break the 78.6% level of XC.
  4. The PRZ (Potential Reversal Zone) of D is a wide range where the price must get to. Price can move anywhere between 38.2% to 61.8%.

I’ve created a simplified approach to how to ‘see’ this pattern.

Simplified Approach (Bullish Cypher)

  1. C must be higher than A.
  2. D must be less than B but greater than X.
  3. We should see a higher high (C > A) and a higher low (D > X).

Simplified Approach (Bearish Cypher)

  1. C must be less than A.
  2. D must be more than B but less than X.
  3. The same approach as above, reverse: lower high (D < X) and a lower low (C < A).

This pattern can be confusing (all harmonic patterns can be complicated), but in a nutshell, what we see happening with the Cypher pattern is the first pullback/throwback of a trend (B). After B, the small pullback/throwback of B occurs with the C leg. From a bullish perspective, when we see prices making lower highs and lower lows, but there is no follow-through shorting pressure, we should be on the lookout for some powerful and influential moves to occur in a very short period of time. It is not uncommon to see a bullish candle engulf several days of consolidation with this pattern.

 

Sources: Carney, S. M. (2010). Harmonic trading. Upper Saddle River, NJ: Financial Times/Prentice Hall.  Gilmore, B. T. (2000). Geometry of markets. Greenville, SC: Traders Press.  Pesavento, L., & Jouflas, L. (2008). Trade what you see: how to profit from pattern recognition. Hoboken: Wiley.

Categories
Forex Harmonic

The Crab Pattern

The Crab Pattern

 

The crab pattern is another of Carney’s harmonic patterns and one of the first that he discovered. The essential condition of this pattern is the extremely tight and resistance endpoint of 161.8% of the XA leg.

Like almost all harmonic patterns, the potential reversal in price action after this pattern has been complete is generally fast, violent and powerful. However, Carney gives special attention to this pattern and reports that it is usually the most extreme of all harmonic patterns.

The pattern is not as frequent as others due to its five-point extension structure. It is desirable to utilize an oscillator to filter entries of this pattern according to any divergence between price and your selected oscillator.

Crab Pattern Elements

  1. B must be a 61.8% retracements or less of XA.
  2. The BC projection can be quite extensive, generally 261.8%, 314%, or 3618%.
  3. An AB=CD 161.8% or an Alternate AB=CD 127% is required for the formation of this pattern.
  4. The extension of 161.8% of XA is the end limit of the pattern.
  5. C has an expansive range between 38.2% and 88.6%.

Sources: Carney, S. M. (2010). Harmonic trading. Upper Saddle River, NJ: Financial Times/Prentice Hall.  Gilmore, B. T. (2000). Geometry of markets. Greenville, SC: Traders Press.  Pesavento, L., & Jouflas, L. (2008). Trade what you see: how to profit from pattern recognition. Hoboken: Wiley.

Categories
Forex Course

7. How Does Profit & Loss Take Place When You Are Trading in Forex?

Introduction

Forex is that market where buying and selling of currency pairs take place. Unlike the stock market, where you need to consider only one stock to analyze, in the forex market, you will have to examine two different currencies to trade one instrument, as instruments here are traded in pairs. Hence, the correlation between currencies plays a major role while trading a currency pair.

Understanding the Current Market Price (CMP)

The current market price (exchange rate) of a currency pair tells you the number of units of the quote currency you’re required to pay to buy one unit of the base currency. For example, let’s say the exchange rate of EURUSD is 1.1000. Here, to buy one unit of EUR, you will have to pay 1.1000 USD. So, basically, while trading a currency pair, you are buying one currency and simultaneously selling the other currency.

Extracting money from the Forex market

Our purpose in this market is to make money. And to make money (profit), understanding the relationship between the two currencies in a currency pair becomes vital. Now coming to the objective, a trader must buy a currency pair when they expect the base currency to have more potential to show strength in the future, comparative to the quote currency. Or in simple terms, to make a profit from a trade, you must go long on the currency pair when you think the base currency will increase in value relative to the quote currency. (Going ‘long’ in Forex is nothing but buying the currency pair and going ‘short’ is nothing but selling it)

Complete trade example

For instance, the CMP of USD/CAD as 1.3240. And let’s say you believe that the USD/CAD is going to drop in the near future. So, you wish to short sell this currency pair. Consider your short sold 10,000 units of USD/CAD. Here, by selling this pair, you have internally sold 10,000 US Dollars and bought the equivalent Canadian Dollars (10,000 USD * 1.3240 = 13,240 CAD). After some days, you see that the prices have dropped to 1.3180. Now, since the value of this currency pair has changed, the 10,000 US Dollars in CAD will be turn out to be, 10,000 USD * 1.3180 = 13,180 CAD. Now, when you sell this currency pair at the CMP, you will actually be buying 10,000 USD and selling 13,180 CAD.

In the above example, let us see if you made a profit or a loss. Initially, you had sold 10,000 USD to buy 13,240 CAD. At this point, you are sitting with 13,240 CAD. Later, you bought back that 10,000 USD, and you paid (sold) just 13,180 for it. That is, you are still left with 60 CAD (13,240 – 13,180) with you.

Hence, you made a profit of 60 CAD ( which is ~45 USD).

Quick cheat sheet

When you buy a currency pair (buy – base currency, sell – quote currency), you need the price of the currency pair to appreciate in value.

Conversely, when you sell a currency pair (sell – base currency, buy – quote currency), you need the price of the currency pair to depreciate in value.

Now let’s check if you understood the concepts right by answering the below questions.

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Categories
Forex Harmonic

The Gartley Pattern

Harmonic Pattern: Bearish Gartley

The Gartley is probably the most well-known pattern in Gartley Harmonics. Gartley himself said that this pattern represents one of the best trading opportunities. Its profitability remains exceptionally resilient. This is especially true when we consider how old the pattern is and how it has remained profitable in these contemporary trading environments. Pesavento reported (at least I think he was the one who wrote this statistic) that it is profitable seven out of ten times and has remained that way for over 80 years. It is important to remember that all harmonic patterns have stringent ruleset. There is no room for interpretation in the construction of any pattern, and the Gartley pattern is no different.

Rules

  1. D cannot exceed X.
  2. C cannot exceed A.
  3. B cannot exceed X.

Characteristics

  1. X is the high or low of a swing.
  2. It is impossible to project or determine A.
  3. Main Fibonacci levels are 38.2%, 50%, 61.8% and 78.6%.
  4. Precise 61.7% retracement XA for B.
  5. BC projections have two specific Fibs: 127% or 161.8%.
  6. The BC projection must not exceed 161.8%.
  7. Symmetrical AB=CD patterns are frequent.
  8. C retracement has a wide range between 38.2% and 88.6%.
  9. An exact D retracement is 78.6% of the XA move.

Sources: Carney, S. M. (2010). Harmonic trading. Upper Saddle River, NJ: Financial Times/Prentice Hall Gartley, H. M. (2008). Profits in the stock market. Pomeroy, WA: Lambert-Gann Pesavento, L., & Jouflas, L. (2008). Trade what you see: how to profit from pattern recognition. Hoboken: Wiley

Categories
Forex Harmonic

AB=CD Pattern

AB=CD Pattern

Bearish AB=CD Harmonic Pattern
Bullish AB=CD Harmonic Pattern

The AB=CD Harmonic Pattern is the most basic and common pattern in harmonic geometry. It is the building block of all other patterns. It is the ‘bread and butter’ pattern. Pesavento and Carney recommended that this pattern should be learned first – and reading this article does not qualify for having learned this pattern. Like any form of analysis, you will need to regularly and consistently train your brain and eyes to find this pattern. You won’t be able to get very far in the study of harmonic patterns until you can see this pattern just by glancing at a chart.

Rules

  1. BC cannot exceed AB.
  2. D must exceed B to form a completed AB=CD pattern.

Characteristics

  1. CD is an extension of AB, generally from the Fibonacci ratio of 1.27% to 2.00%.
  2. CD’s slope is steep or longer/wider than AB.
  3. BC often corrects to the Fibonacci ratios of 38.2%, 50%, 61.8%, or 78.6%.

 

AB=CD Pattern Reciprocal Ratios

Point C Retracement BC Projection
38.2% 24% or 261.8%
50% 200%
61.8% 161.8%
70.7% 141%
78.6% 127%
88.6% 113%

 

Sources: Carney, S. M. (2010). Harmonic trading. Upper Saddle River, NJ: Financial Times/Prentice Hall Gartley, H. M. (2008). Profits in the stock market. Pomeroy, WA: Lambert-Gann Pesavento, L., & Jouflas, L. (2008). Trade what you see: how to profit from pattern recognition. Hoboken: Wiley

Categories
Forex Course

3 – Reading & Understanding The Currency Pairs

Introduction 

From the previous lesson, we know that global currencies are traded in the Forex market. These currencies are exchanged in pairs. We also understood what Major, Minor, and Exotic pairs are. In this lesson, let’s discuss more characteristics of these currency pairs.

Out of the three types of currency pairs, the most traded type are Majors. These major pairs contribute more than 85% of the total Forex trading volume. Prices in these pairs move in tighter spreads, but they are a bit volatile during market opening hours. Major pairs are those who have USD in them. Some of the major pairs are EUR/USD, USD/JPY, GBP/USD, and USD/CHF. The other vital pairings which do not include the US dollar are known as ‘cross currencies.’ Some of these are GBP/EUR, EUR/CHF, EUR/JPY, etc.

Reading a Currency Pair

Since we are talking about currency pairs and the Forex market, it is essential to learn how to read them. Every currency has a three-letter symbol defined by the International Organization for Standardization(ISO), which is straight forward. Below is the terminology for some of the major currencies.

  • British Pound for GBP
  • US dollar for USD
  • Japanese Yen for JPY
  • Swiss Franc for CHF
  • Euro for EUR

To understand the reading of a currency pair, you need to know the meaning of base and quote currencies. The first currency in a Forex pair is called base currency, and the second one is called quote currency. As we know, trading the Forex market involves selling one currency to buy the other. For instance, we sell the base currency to buy the quote currency. Let’s say you are trading USD/CAD. USD is your base currency, and CAD is your quote currency. Here, when we are executing a sell trade on this pair, we are primarily selling USD to buy CAD. And vice-versa if you are placing a buy trade.

How much one unit of the base currency is worth against the quote currency defines the price of a pair. In the above example, if USD/CAD is trading at 1.32267, that means one US dollar is worth 1.32267 Canadian dollars.

Liquidity of Major Pairs

Liquidity in these pairs is the highest when compared to other pairs. The larger the import/export value between two nations, the more liquid the currency pair of these countries will become. EUR/USD is the most liquid pair in the world. Major currency pairs should not be confused as the best currency pairs to trade. Trading a particular currency pair depends more on strategy and market sessions. When we say ‘major,’ we mean the most actively-traded Forex pair. The six most actively-traded Forex pairs are:

  • EUR/USD
  • USD/JPY
  • GBP/USD
  • USD/CAD
  • USD/CHF
  • AUD/USD

One of the reasons behind these currencies being traded so extensively is the political and economic stability associated with these currencies. Big investors feel it is safe to park their money in such economies.

What Should You Trade?

If a currency pair has high liquidity, the volatility of that pair decreases. Currency pairs that are linked with the market openings should be our first choice. For example, it is recommended to trade the US dollar during New York open or trading the Australian dollar during Asia opening, as there will be good volatility during this time. Also, consider economic news releases, technical chart analysis, and other events while choosing the currency pair to trade. For people who have just begun their Forex trading journey, it is recommended to start trading major currency pairs before experimenting with minors and exotics. Now try answering the below questions.

[wp_quiz id=”41992″]
Categories
Forex Indicators

MACD – Moving Average Convergence Divergence

The MACD

Fig 1- Chart with MACD. Click on it to enlarge

The Moving Average Convergence Divergence (MACD) is probably one of the most popular and well-known oscillator indicators in any market. It is one of our ‘modern’ indicators; created by Gerald Appel in the late 70s. It is essentially a two-part tool that traders can utilize.

  1. Provides a quick look to see the direction and trend of your market using two lines/moving averages: the MACD line and a signal line.
  2. It provides a divergence detection tool using a zero line and histogram.

The MACD line and the Signal Line

The first of these parts of the MACD is probably the one used most often, the MACD line and the signal line. General strategies related to the MACD is that you should consider taking a buy when the MACD line crosses above the signal line and sell when the MACD crosses below the signal line. Additionally, some strategies suggest more conservative entries based on when the MACD crosses the middle line (0-line).

The Histogram

The second part of the MACD, and perhaps the one that confuses many new traders, is the histogram with the 0-line. The histogram shows the difference between the MACD line and the signal line, basically, is showing the ‘gap’ between the two lines, as they grow and diverge away from one another, the histogram expands. However, the real strength of this is the ability to see divergences.

Pros and Cons

The downsides to the MACD indicator is that it is very notorious for causing whipsaws in traders. Whipsaws can be avoided by not using the MACD as your sole indicator of trade signals. The MACD is an excellent tool to help confirm your trades in a trending market, but it is not suitable for a ranging market. If you are a new trader, the MACD is a fantastic tool to help you train and learn about how indicators work. Spend some time watching markets live on smaller time frames and look at how the MACD works and moves with that market. You will notice things you like (i.e., identifying the trend and strength of that trend) and the things you don’t like (i.e., too many signals/crosses on short time frames).

A word of caution

I would caution against using the MACD in your trading. The MACD is an old indicator, and it is most useful as a tool for analysis on daily timeframes or weekly time frames. Because it is so well known and used so much by new traders, it is used against new traders. It is one of those indicators use to entice new traders into using – like bait. Just like moving averages, the MACD has several strategies that involve a crossover. A crossover strategy is simple to understand and easy to learn the strategy and so many new traders try to use this as one of their first strategies – but it doesn’t work. It may seem like it works, but it doesn’t. Again, the MACD is an indicator that is entirely lagging in nature. It is showing what has already happened, not what will happen. It’s most effective use will be a tool for detecting divergences – but even then, there are better indicators and oscillators out there for detecting divergences.

Categories
Forex Course

Introduction To The ‘Ultimate Forex Course’ By The Forex Academy!

At Forex Academy, we give utmost importance to education. To be successful, you need to learn before you Earn. So for that same purpose, we have designed a proprietory course helped by industry experts. This extensive course will cover almost everything one needs to know about the Forex market. All relevant aspects of the trading business will be discussed here, starting right from the fundaments to the advanced trading concepts. We will be publishing one article per day so that it will be a continuous learning process. And guess what? The curse is entirely free for our readers.

Introduction To The Course

In this one-of-a-kind course, we will explain everything you need to know about Forex trading. The Forex market has evolved rapidly in recent times. It is not the same that you would have seen or heard a decade ago. The fundamentals are changing, psychology is changing, and complexity has increased. Technology not available in the 90s has now become robust and is being used extensively by traders and banks. As retail traders, we should prepare as best as possible to meet these global changes.

We have created this course, keeping in mind the rapid changes happening in the forex market. You need to use a structural method of learning, which is what we have done. Education shouldn’t be in bits and pieces, this will only create confusion, and you cannot gain anything from that knowledge. You will gain an insight into fundamental and technical expertise and how you can use them together to make the best trades. We have compiled this information from the best sources. Most importantly, the course contents have been written based on the personal experience of the writers. Forex.Academy is the right place to start for any person looking to start his trading career.

Why should you take up this course?

If you want to achieve your investment goals, this course is for you. Trading is not an easy game. It requires a lot of hard work and dedication. This journey begins with learning, and learning starts here. This course is a complete package for all the aspiring traders. Also, experienced traders who are willing to expand their knowledge must try this course. The articles are more reader-friendly, where topics are explained in simple language. The most complex strategies are described in the easiest way possible. Without having the right knowledge, it is impossible to succeed in trading.

Structure of the course

The course is divided into 37 chapters which comprise of 350+ articles, where a wide range of topics are covered. The chronological order of topics is in such a manner that every chapter is linked to the next. We have made sure that it does not lead to confusion at any point. You will find information on fundamentals, technical analysis, and price action. Market psychology is one such topic, which has been written with a lot of attention. And you too, should follow these principles to gain control over your mind.

Keep track of your learning with the quizzes

At the end of each article, we have included a quiz that will test your understanding of the topic. To be confident about what you have read, try to answer all of them correctly. If you are unable to answer, that means you need to reread the article. Rereading the article will clear all your doubts and make you an expert. Once you got all the answers right, you are ready to go ahead to the next section.

What will you learn by the end of this course?

By the time you reach the end of the course, you will be halfway through your trading journey. The only thing left for you to do is to practice the trading strategies discussed along the course. You will have all the knowledge you need to be a successful trader. See you on the course.

All the best! Happy Learning!

Categories
Cryptocurrencies

Investing in an Early Stage of an ICO

Are projects (ICOs) worth looking at in the early stages?

This article will show you that while investing, one does not have to follow the crowd in order to be successful. During times where market timing is not in the best spot (with the whole crypto market going down) and people not wanting to diversify gains, as they rarely have any, people are scared of investing in ICOs. Most people just follow the crowd and the hype when it comes to ICOs. There are, however, many more factors that need to be included in the analysis. My previous articles have shown that an ICO needs to be looked at from many perspectives (token economics, team, social media, SEO part of the website…). But, what happens when an ICO is in the early stages?

Early-stage ICOs

Investing in the early stages of an ICO might be the way to acquire the best bonuses. But it is also a big risk, as there is usually not enough data for a conclusive analysis. So how do we determine if a project is worth investing in?

1. Project Idea – the most important thing with every ICO is the idea. It’s a problem they are trying to solve and the lifeline of their project. You can always judge the potential acceptance of the idea when it comes to ICOs, no matter how early it is in the project.

2. Team –it’s what makes the idea go from vision to reality. If we are looking at early-stage ICOs, this becomes even more important, as this is one of the few things we can just get it on. Both team and advisory board need to be impeccable.

3. Roadmap – Less value than the first, too, but is used to estimate the investment time frame.

4. Potential social media coverage – this part will probably be non-existent as the project is in the very early stages. However, some influencers might be on it as fast as you are.

5. The X factor – something that will intrigue other people. It is usually some part of the idea or their monetization plan.

What is important and noticeable here is: I didn’t list token economics or Hype/market traction anywhere. This is because we are looking at a potential gem project way too early for them to have these.

Conclusion

Early-stage ICOs are potential moneymakers and can bring you amazing returns. However, we are operating with insufficient data in the ICO analysis, so it brings a lot more risk. This means that compromising on any of the factors analyzed will cost people their investments. I would advise picking only the best of the best ICOs to invest in early on, or just keep an eye on them and wait for the data to present and the investment to be safer (and reliable).

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 Psychology

The Importance of Mastering Trading Psychology

Introduction


As traders, we tend to learn the technical stuff and focus our attention on improving our technical analysis. Which is ok, but often, learning trading psychology is neglected. And at the end of the day, it is you who’s in charge of decision making, and you are the one entering your orders.

In my mind, mastering trading psychology is more important than learning chart patterns, complex wave theories, Fibonacci levels, etc. Even a layman can spot a trend, but then the decision has to be executed – do you buy or sell?

Our emotions govern decision making as they impact our rational thinking. You can do an exceptional technical analysis, but you may still lose money. You can do a poor technical analysis and still earn money.

The question imposes: why are traders who are knowledgeable about technical analysis still lose money?

The answer lies in the difference between real life and the markets and the ways we are conditioned to behave in real life vs. the mindset that is needed to be profitable in the markets.


Real-life vs. the markets


Cutting your loses 

In real life, people are not accustomed to losing. If your finger gets trapped inside the elevator hole, you would probably turn on the alarm, stop the entire building from using the elevator and call the fire brigade to help save your finger, right? You wouldn’t just cut it off and continue with your day because, in real life, fingers don’t grow back.

In the market, if your finger gets caught and you try to save it with your other hand, the other hand will get trapped as well, and you will lose both hands. So the solution would be to just cut your finger, as in the markets, fingers do grow back!

As you may have figured, the Finger analogy is when your position is starting to go against you. If you sit there and wait for it to bounce back, hoping you wouldn’t lose your money, you will lose more money. And the only solution is to cut your losses early on and have confidence that you will be in profit next time when you will be compensated for your losses and be in profit overall.

So this response has to be learned, as we have been conditioned to behave and think differently.

You shouldn’t be right, you should be in profit. 

Traders often feed their ego with their good analysis. Your ego tends to think that you should always be right and that being wrong is a very, very bad thing. That can sometimes create a bias rationale. For example, you have done tons and tons of research, and your fundamental and technical analysis; so, you have concluded that it’s a buy. You put your buy order.

After a day or two, you are in profit, good. But on the third day, the trade is starting to go against you. You keep saying to your self “it’s only a correction” I have done my research, and this can’t go down further. But it does. Even though you see you are losing money, you tend to keep your position opened. Why is that? Your brain creates a bias. It can’t even see an alternative bearish scenario, so you become loyal to yourself, as your ego also keep you congruent.

In real life, loyalty and congruency are great. If we didn’t have those traits, we would all be unreliable and spinless beings, and society as we know it would fall apart. But in the markets, you have to be able to adapt.

This is not about being right, you are not a fortune teller, you are a trader.

Numbing your emotions and the difference between knowledge and behavior 

Expanding your knowledge about financial markets and the ways of analyzing them is great, but you have to internalize it into your behavior patterns. For example, I smoke cigarettes, and I know that they are harmful. The knowledge about the harmful effects of smoking is not overpowering my internal emotions of the desire to smoke.

Another example is exercise. We all know that we should eat healthy food and exercise. But the fast-food tastes good, and our emotions are governing our decision making, and we end eating that burger. Our laziness chains us to our beds, and we hit that snooze button and sleep an extra hour, leaving us without any time to run in the morning.

That is why we, as traders, need to suppress our emotions of greed and fear that can impact our decision making.

Patience

In the modern-day world, we are bombarded with information through social media. If something doesn’t appear interesting, we are hesitant to watch it to the end. That conditions us to follow our attention and not to be in charge of it. And that’s ok in real life, as our attention is limited, and with so much out there, it would be impossible to keep track of everything.

But in the market, you have to leave that urge behind to know if it is a buy or sell, and get it over with. Trading is an activity.


Conclusion


The market environment is diametrically different from the real-life environment – it’s totally unpredictable, and we need a totally different mindset to overcome the challenges of surviving in that environment.

In real life, you would go to a train station ask a clerk where the next train is going, and if you like the direction, you would sit on that train, take a nap, and when you wake up, you would arrive at your desired destination. It is predictable, and we are accustomed to that predictability, and our behavior has been built around that predictability.

You would check your indicators in markets, make your projections, ask people what they think, where the train is heading, and still won’t have a definitive answer.

That’s why mastering trading psychology is so important. It is the way to help you find the right mindset to manage the unpredictable nature of the markets, and here at Forex Academy, we are here to help with our services.

Categories
Forex Educational Library

The Trading Record

Introduction

Traders want to win. Nothing else matters to them; and they think and believe the most important question is timing the entry. Exits don’t matter at all, because if they time the entry, they could easily get out long before a retracement erases their profit. O so they believe.

That’s the reason there are thousands of books about Technical Analysis, Indicators, Elliott Wave Forecasting, and so on, and just a handful of books on psychology, statistical methods, and trading methodology.

The problem lies within us, not in the market. The truth is not out there. It is in here.

There are a lot of psychological problems that infest most of the traders. One of the most dangerous is the need to be right. They hate to lose, so they let their losses run hoping to cover at a market turn and cut their gains short, afraid to lose that small gain. This behavior, together with improper position sizing is the cause of failure in most of the traders.

The second one is the firm belief in the law of small numbers. This means the majority of unsuccessful traders infer long-term statistical properties based on very short-term data. When his trading system enters in a losing streak, they decide the system doesn’t work, so they look for another system which, again, is rejected when it enters in another losing sequence and so on.

There are two problems with this approach. The first one is that the trading account is constantly consumed because the trader is discarding the system when sits at its worst performance, adding negative bias to his performance every time he or she switches that way. The second one is that the wannabe trader cannot learn from the past nor he can improve it.

This article is a rough approach to the problem of establishing a trading methodology.

1.- Diversification

The first measure a trader should take is:

  1. A portfolio between 3-10 of uncorrelated and risk-adjusted assets; or
  2. A portfolio of 3 to 5 uncorrelated trading systems; or
  3. Both 1 and 2 working together.

What’s the advantage of a diversified portfolio:

The advantage of having a diversified portfolio of assets is that it smooths the equity curve and, and we get a substantial reduction in the total Drawdown. I’ve experienced myself the psychological advantage of having a large portfolio, especially if the volatility is high. Losing 10% on an asset is very hard, but if you have four winners at the same time, then that 10% is just a 2% loss in the overall account, that is compensated with, maybe, 4-6% profits on other securities. That, I can assure you, gave me the strength to follow my system!.

The advantage of three or more trading systems in tandem is twofold. It helps, also improving overall drawdown and smooth the equity curve, because we distribute the risk between the systems. It also helps to raise profits, since every system contributes to profits in good times, filling the hole the underperforming one is doing.

That doesn’t work all the time. There are days when all your assets tank, but overall a diversified portfolio together with a diversified catalog of strategies is a peacemaker for your soul.

2.- Trading Record

As we said, deciding that a Trading System has an edge isn’t a matter of evaluating the last five or ten trades. Even, evaluating the last 30 trades is not conclusive at all. And changing erratically from system to system is worse than random pick, for the reasons already discussed.

No system is perfect. At the same time, the market is dynamic. This week we may have a bull and low volatility market and next one, or next month, we are stuck in a high-volatility choppy market that threatens to deplet our account.

We, as traders need to adapt the system as much as is healthy. But we need to know what to adjust and by how much.

To gather information to make a proper analysis, we need to collect data. As much as possible. Thus, which kind of data do we need?

To answer this, we need to, first look at which kind of information do we really need. As traders, we would like to data about timing our entries, our exits, and our stop-loss levels. As for the entries we’d like to know if we are entering too early or too late. We’d like to know that also for the profit-taking. Finally, we’d like to optimize the distance between entry and stop loss.

To gather data to answer the timing questions and the stop loss optimum distance the data that we need to collect is:

  • Entry type (long or short)
  • Entry Date and time,
  • Entry Price
  • Planned Target price
  • Effective exit price
  • Exit date and time
  • Maximum Adverse Excursion (MAE)
  • Maximum Favourable Excursion(MFE)

All the above concepts are well known to most investors, except, maybe, the two bottom ones. So, let me focus this article a bit on them, since they are quite significant and useful, but not too well known.

MAE is the maximum adverse price movement against the direction of the trend before resuming a positive movement, excluding stops. I mean, We take stops out of this equation. We register the level at which a market turn to the side of our trade.

MFE is the maximum favourable price movement we get on a trade excluding targets. We register the maximum movement a trade delivers in our favour. We observe, also, that the red, losing trades don’t travel too much to the upside.

 

Having registered all these information, we can get the statistical evidence about how accurate our entry timing is, by analysing the average distance our profitable trades has to move in the red before moving to profitability.

If we pull the trigger too early, we will observe an increase in the magnitude of that mean distance together with a drop in the percent of gainers. If we enter too late, we may experience a very tiny average MAE but we are hurting our average MFE. Therefore, a tiny average MAE together with a lousy average MFE shows we need to reconsider earlier entries.

We can, then, set the invalidation level that defines our stop loss at a statistically significant level instead of at a level that is visible for any smart market participant. We should remember that the market is an adaptive creature. Our actions change it. It’s a typical case of the scientist influencing the results of the experiment by the mere fact of taking measurements.

Let’s have a look at a MAE graph of the same system after setting a proper stop loss:

Now All losing trades are mostly cut at 1.2% loss about the level we set as the optimum in our previous graph (Fig 2).  When this happens, we suffer a slight drop in the percent of gainers, but it should be tiny because most of the trades beyond MAE are losers. In this case, we went from 37.9% winners down to 37.08% but the Reward risk ratio of the system went from results 1.7 to 1.83, and the average trade went from $12.01 to $16.5.

In the same way, we could do an optimization analysis of our targets:

We observed that most of the trades were within a 2% excursion before dropping, so we set that target level. The result overall result was rather tiny. The Reward-to-risk ratio went to 1.84, and the average trade to 16.7

These are a few observations that help us fine-tune our system using the statistical properties of our trades, together with a visual inspection of the latest entries and exits in comparison with the actual price action.

Other statistical data can be extracted from the tracking record to assess the quality of the system and evaluate possible actions to correct its behaviour and assess essential trading parameters. Such as Maximum Drawdown of the system, which is very important to optimize our position size, or the trade statistics over time, which shows of the profitability of the system shrinks, stays stable or grows with time.

This kind of graph can be easily made on a spreadsheet. This case shows 12 years of trading history as I took it from a MACD trading system study as an example.

Of course, we could use the track record to compute derived and valuable information, to estimate the behaviour of the system under several position sizes, and calculate its weekly or monthly results based in the estimation, along with the different drawdown profiles shaped. Then, the trader could decide, based upon his personal tolerance for drawdown, which combination of Returns/drawdown fit his or her style and psychological tastes.

The point is, to get the information we must collect data. And we need information, a lot of it, to avoid falling into the “law of small numbers” fallacy, and also to optimize the system and our risk management.

Note: All images were produced using Multicharts 11 Trading Platform’s backtesting capabilities.

Categories
Forex Trading Strategies

STRATEGY 1: CONTEXT PLUS DOUBLE CONFLUENCES

Forewords

All these strategies are based on setups that have prior market reading knowledge, which is just as important as the pattern itself. We recommend you to learn using Forex Academy’s educational articles and videos to contextualize the market, so you are always aware of the present situation.

That said, let’s see what this strategy consists of and how we apply it to the market.

The Strategy

A confluence is nothing more than a price level where two or more key levels converge that act as support or resistance. If you are in a Bull market context, and you see that the price falls back to an area where two or more supports come together, you will have a pattern to enter the market long.

We are going to see some real examples in the graphs so that we can understand better what we are showing.


On this chart, we see the Dow Jones index in the 60-minute timeframe. A few days ago, the price had decreasing highs, which allowed us to draw a bearish trendline. That trendline was broken with an upward momentum, which turned the old resistance into a possible future support zone if the price were to pull back on it.

Looking at the short term, we also observe that the latest market lows were increasing, a situation that always calls for a bullish trendline. We see on the chart that there is an exact place where these two guidelines converge and that the price comes to a support level near this figure. This gives us a very good area to enter a long position, protected by two supports. Also, in the graph, we can see that the 200-period Moving Average is moving just below it, which provides even more value to the area.

Let’s see another example, but with resistance in this case.

In this image, we can see the 1-minute DAX index chart. We observe how the price is producing decreasing highs, which allows us to draw a bearish trendline.

In the first half of the current session, the price opened with a bearish gap and closed with bullish momentum. Then the market turned down to a bearish momentum that ended with a false dilation of the lows. If we draw the Fibonacci retracements on that bearish momentum, we can see how the Fibo-62 guideline converges in the same area, creating an important resistance where the price is likely to rebound. The red arrow would show the short-entry zone in this case.

In these two examples, there is no indication of whether we have a context for or against because that requires a much more in-depth analysis of various times frames. But as we have already mentioned, to learn how to assess the context, you will need to study on live markets with the help of experienced traders.

If you combine a favorable context, that is, a setting showing you the likely direction of the market, and a zone of confluences where the market can support and continue to favor the context, you would be able to build very powerful setups.

 

© Forex.Academy

Categories
Forex Trading Strategies

SMA Crossover Strategy with a twist

Introduction

Some centuries back, Karl Friedrich Gauss showed that an average is the best predictor of stochastic series.

Moving averages are employed to grade the price.movements. It acts as a low-pass filter, taking out the fast changes in price, regarded as market noise. The period of the moving average controls how smooth is this low pass filter. A  three-period MA levels the action of three periods, while a 200-period MA produces a single value of the last 200 price values.

Usually, it is determined using the close value of the bar, but there can be made also of the open, high or low of the of bars, or a weighted average of all price points.

Simple Moving Average(SMA):

This average is computed as the sum of all prices on the period and divided by the period.

The main drawback of the SMA is its abrupt change in value if a significant price move is cut off, particularly if a short period has been chosen.

Averages with different periods result in different measures that can be thought of as a fair price during that period. Thus, if we observe two averages, a long-term and a short-term MA, and the short-term average moves above the long-term average, we might conclude that the new opinion about the price is changing, so it’s a good time to buy.  The converse holds if a short-term average falls below the longer-term one.

The Parameter Space

Let’s analyse the parameter space of a moving average crossover strategy. This strategy has only two parameters: The fast-MA period, and the Slow-MA period.

We use a simulator on a EUR-USD 15-min chart over a historical record of nearly 14 years and computed the returns using a constant one-lot trade, and the result is shown in the figure below. We go long when the fast MA crosses over the slow MA and price is above the fast MA. The opposite holds for short positions.

We observe that the map is somewhat un-smooth, with its better performers at about 60-70 periods for the slow MA and less than five periods for the fast MA.

The other fact is that only 48 out of 304 simulations deliver positive results, this shows us that the strategy is questionable without other parameters that might improve its performance.

Testing  the popular 5-10 Periods SMA

I have seen some people boosting a system that goes long when the 5-period MA crosses over the 10-period MA,  and short on opposite crosses, but as far as I had seen when I tested it, this strategy loses 32,000 Eur at the end of 14 years ( below its equity curve)

The use of trail-stops and targets can make this strategy positive, but the equity curve is hopelessly untradeable:

So what may help to improve this strategy?

Well, I thought about two ways. The first one is to move the slow MA period to about 70.

Well, that is a good improvement, although we have losing periods, it, definitely, is much better to use a longer-period parameter on the slow average.

What happens, if we add the condition that the slow MA should be pointing UP and prices above the slow MA?

 

When applying these rules, we observe that the better-performing slow-MA period moves around 80 bars, and the fast MA period stays at less than 5. Another point we observe is that the slow MA surface is smoother around 80 periods. This is a sign that we’ve found a right place for our parameters. Finally, in this simulation, 500 out of 735 simulations are in positive territory. That shows us that we have found a more robust strategy because 80% of the parameter values deliver positive outcomes.

So, that will be the basis of our moving average crossover strategy.

The Rules of the strategy:

Periods: Slow MA: 75, fast SMA: 3

Initial Stop-loss: 0.18%. This mean, we cut our losses if it crosses 0.18% away from our entry price.

Trailing stop-loss: 0.38%. We let the trade room to catch the trend.

For long entries:

1.- We define a bull market when the Fast SMA crosses over the Slow SMA

2.- We allow long positions only when the slow SMA points upward, meaning its current value is higher than its previous one.

3.- We buy when the price closes above the Slow SMA.

For short entries:

1.- We define a bear market when the Fast SMA crosses under the Slow SMA

2.- We allow short positions only when the slow SMA points downward, meaning its current value is smaller than its previous one.

3.- We sell short when the price closes below the Slow SMA.

The equity curve is much better, although it shows the typical equity curve of a trend-following system.

The Total Trade Analysis shows why. The system’s percent winners are 27.33%, and the reward-to-risk ratio is 3.5 (Avg Win/Avg Loss ratio). That tells the system is robust, by priming profitability over the frequency of winners.

Main metrics of the Donchian System, on the EUR-USD:

It’s not usual but, from time to time we may expect a streak of up to 20 losing trades, therefore we need to apply proper money management.

As an example, let’s say, you don’t like to have a drawdown higher than 25% of your running capital, then you need to divide that figure by 20, and that must be your maximum risk for a single trade, therefore, in this case this is 1.25% of the current capital allocated for this strategy.

How to trade this strategy on your JAFX MetaTrader 4:

Adding a moving average to a naked candlestick chart is simple:

A popup window appears after clicking “Moving Average”:

There you are able to set the period and MA method, Price to apply. We change just the period, and select the “Weighted Close (HLCC/4)” We may, also change the color of the Slower MA to a different color, so every MA has different colors.

© Forex.Academy

Categories
Forex Trading Strategies

Volatility Expansion Strategy

Overview

 

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.

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.

The variability of a data set may be calculated using different methods. One of the most popular in trading is the range.

Range:  The range is the difference between the highest and lowest points in a data 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.

The Strategy

The Volatility Expansion Strategy rationale is that a sudden thrust in the volatility in the opposite direction of the current momentum predicts further moves in the same direction.

For this strategy, we are going to use the Range as a measure of volatility. Specifically, we are going to use the Average True Range indicator to spot volatility sudden changes.

The rules of the strategy are:

Long Entries:

Set a buy stop order at Open + Average( Range, Length ) * NumRanges  next bar

Short Entries:

Set a stop sell short order at Open – Average( Range, Length ) * NumRanges next bar

The parameters are the Length of the average and the NumRanges for longs and shorts.

Manage your trade using a trailing stop.

Let’s see how an un-optimized system performs under 14 years of EUR_USD hourly data:

The standard parameters are:

 Length: 4

NumRanges: 1.5

As we can observe, the actual raw curve is rather good, showing a continuously growing equity balance. ( click on the image to enlarge)
The Total Trade Analysis for single-contract trades shows a nice 2:1 Reward to risk ratio (Ratio Avg Win/Avg Loss) and a 35% winners.

Analyzing the Parameter map:

As we observe in fig 5, there are two areas A and B where to locate the best parameters for this strategy. The surface is smooth, thus, guarantying that a shift in market conditions won’t harm too much the strategy. For the sake of symmetry we will choose the A region, thus, the Long ATR length will be 10 and the short ATR length is left at 13.

Fig 6 shows the map for the NumRanges That weights the ATR value and sets the distance of the stop order from the current open. The surface is, also, very smooth. Therefore we can be relatively sure that setting the NumRages value to 1.3 in both cases we will get good results.

The new equity curve has improved a lot, especially in the drawdown aspect, and in the overall results, as well, although we know this isn’t a key aspect because this equity result was achieved with just a single-contract trade.

This kind of strategy incorporates its stops because it’s a reversal system. Therefore there is no need for further stops or targets.

In fig 8 we observe that the percent winners are close to 39% while the risk to reward ratio represented by the ratio Avg win/ Avg loss is 1.9. Also, we see that the average trade us 28.5 euros which is the money expected to gain on every trade. That shows robustness and edge.

Main metrics of the Volatility Expansion System, on the EUR-USD

(click on the images to enlarge)

As a final note, one way to perform semi-automated trading using a volatility  expansion is the free indicator Volatility Ratio, from MQL5.com

When you click on the Download button, a pop-up window appears:

When you click on the Yes,  this indicator is installed automatically in your MT4 platform. To use it on a chart you just go to Insert -> Indicators -> Custom-> Volatility Ratio, as shown below:

 

The Options window for this indicator allows you to toy with the parameter values, but I advise you to keep the default values and paper trade them, so you get the idea about how it works and how parameter changes may affect its effectiveness and the number of trade opportunities.

Finally, this is the type of chart annotations of this indicator:

(click on the image to enlarge)

Categories
Forex Educational Library

Trading Using the Elliott Wave I

Introduction

An essential “first step” for a trader who aspires to reach success is to fully understand how markets work, the deepest dynamics if you will. I.e., that certain tool or criteria that would allow him to decide whether or not to enter, and if so, at which price, as well as possible “escape” routes. There is something which novice participants struggle with, and it deals with the apparent chaotic randomness depicted by price, especially in short time-frames. In fact, visualising markets as a jungle with innumerable dangers, hidden pitfalls, and an overwhelming uncertainty would better clarify this point. Yet, traders need a map, and this article is about one possible way to draw it.

To succeed, participants must get rid of a frequent bias consisting in their belief that trading financial instruments is about keeping a high success rate on entries; moreover, a common mistake is to associate profits with earnings. You would be surprised at the following statistically-corroborated fact: while frustrated retail traders reach, on average a success rate of up to sixty-five percent (65%), consistent professional ones barely overtake the bar of twenty-five percent (25%)!  That is possible because trading is not gambling. After all, trading is not about gambling; instead, the two critical elements involved are accuracy when entering the markets and the risk-reward ratio.

Thus, a given methodology can be profitable even with success rates as low as ten percent (10%) when holding a risk-reward ratio of over than 10 to 1. That shows that we don’t need to predict the market. The real secret is to search and find situations where we could detect a high reward to risk ratio. On a reward to risk of N, we just need to be successful once every N trades. That’s a fact. Undertaking the risk-reward ratio as the filtering criteria is the trick towards successful trading, i.e., discarding scenarios with low ratios to protect us when dealing with losing streaks. After all, if the odds turn against us while keeping a high ratio as hardcore in our analysis, all we have to do is to wait for the tides of prices change back in our favour.

Going back to our jungle and map metaphor, Elliot Wave Theory, coupled with Fibonacci retracements and extensions serve as a framework of reference when applying our preferred trading methodology, and filter setups with an optimal combination of success rate and risk-reward ratio.  We must warn the reader that our approach to The Elliott Wave Theory will not be conventional. Just like it is often introduced as a “crystal ball” with magical forecasting properties, we shall focus on those features oriented towards the achievement of more suited setups, entries and targets from a risk-reward ratio standpoint.

For those who wish to deepen their knowledge of more advanced Elliot principles, we’ve included a bibliography section at the end of this article.

 

The basics of the Elliott Wave Principle

The basis of the Elliott Wave analysis is this: The market moves in a fractal pattern of waves, but the basic model is formed by an impulsive wave and a corrective wave, which, at its end, marks the beginning of another impulsive wave.

Within this idealised Elliott world, the impulsive phase is a pattern of five waves. Three of them have an impulsive nature and two have corrective.

The corrective wave pattern is composed of 3 waves, two impulsive and one corrective. Elliotticians identify them by using letters.

 

N.R. Elliott observed that wave patterns form larger and smaller versions of the main wave pattern. This repetition means that price behaves in a fractal manner. By keeping the wave count, traders can identify how old the current trend is and the likely place when a new one begins.

 

Points about Elliott Wave Analysis that helps in trading:

  1. Identifying the main trend direction.
  2. Visualising counter-trend legs.
  3. Determining the trend maturity.
  4. Defining potential targets.
  5. Specific invalidation points.

 

Identifying the main trend and why is it important

Impulsive waves are the easiest to trade. It’s the path of least resistance, and where reward to risk is highest. Corrective segments are hard, with a lot of volatility and noise, because it’s a place where bulls and bears fight to take control of the price. Fig 5 shows a risk to reward study on both waves, on a EUR/USD daily chart, from March to August 2015. We observe that corrective waves are noisy, with limited rewards for the risk. Impulsive waves are exuberant and optimistic, this is where we can optimise this ratio. Therefore, it’s wise to trade with the trend.

Identification of the primary trend is quite straightforward: It’s the direction pointed by one or several previous impulsive legs, in the case of Fig 5 it’s obvious we are at an uptrend.

Visualisation of Countertrend Legs

Corrective segments are places of recess from the impulsive phase. The impulse has travelled too far, according to the participants, and some of them take profits, while others sell short.

But, corrective waves are continuation patterns. Therefore, a C wave edge identifies a place of low risk and high reward to start trades aligned with the primary trend. Examples of what I mean is the end of c waves in Fig 5 that signals the beginning of a new and tradable impulsive pattern in the main trend direction.

Trend maturity determination

As we observe in Fig 4, market waves form wave patterns within wave patterns in a continuous fractal fashion. We see that wave [1] subdivides into five small waves. Therefore, we can identify the maturity of prices by looking at where they are on the wave map.

Definition of price targets

Price target assessment is done using Fibonacci ratios and one to one projections in rising channels.

Fibonacci and projections will be discussed later in more depth. On Fig 6 we see a projection example using the same EUR/USD chart from Fig 5. The line from C to 1 is copied and projected in wave 3,  starting at the end of wave 2. The length and angle are unchanged. The same projection is repeated (because wave 3 ended just as forecasted by that line) to find the end of the 5th wave. In that case, we noticed that this wave had an over-extension and this projection fell short.

The same operation can be performed on corrective waves. On Fig 6 we see an example to forecast the end levels and times of wave 4 by projecting the line drawn on wave 2.

Specific invalidation points

Knowing when the trade scenario is no longer valid is the most critical piece of information a trader needs. The wave rules give specific levels at which that scenario has failed and when the count is invalid.

Specifically, three rules help us find those invalidation levels.

  1. Wave 2 can never retrace more than 100% of wave 1.
  2. Wave 4 should never end beyond the end of wave 1.
  3. Wave 3 can never be the shortest.

 

A violation of these rules implies that the wave count is invalid. That will help us determine if the trade has a reward worth its risk, even before entering the trade. We should avoid less than 1:1 reward-to-risk ratios, as we have discussed in the introduction to this article.

The most profitable waves to Trade

As we have discussed before, the most profitable waves are impulsive, because they are following the direction of the primary trend.

And which waves of the total Elliott cycle are impulsive?

  • They are waves 1, 3, 5, A and C. Waves 2, 4 and B are corrective.

Particular care should be taken when trading wave 1 since the latest wave was an impulsive wave in the opposite direction, so the pattern of trend change hasn’t been established, and, usually, wave 2 corrects almost 100% of its gains. Therefore, it’s better to wait until the end of a wave 2 pullback than risking too early on a wave 1 wannabe.

We should remember that a five-wave pattern determines the direction of the main trend, while a three-wave pattern is an opportunity to join the trend.

Hence, the final count for profitable trading following the main trend are waves 3, 5, A and C.

Fig 7 shows the Elliott Wave setups. To the left, the bull market setups, while to the right the bearish market version.

As seen above, these setups, except at the end of wave 5, are entries on the main trend pullbacks, at the end of corrective waves. That makes sense because we know that impulsive waves depict much higher rewards for its risk. The second consideration is that at the end of these waves we achieve our goal to optimise the risk-reward of trades. Therefore, at least theoretically, they are as perfect an entry as they may possibly be.

Important methodology to profit from the Elliott Wave

The first rule has been already said: Trade with the trend. Just trade when a primary trend has been established.

The second rule is, let the market show you a confirmation, for example, a price breaking a strategic high or low, price breaking out of a triangle formation and so on.

The third rule has already been mentioned: We are business people. Therefore, we should seek a proper reward for our risk. We have already mentioned the importance of high reward-to-risk ratios. A ratio of 3 allows us to be profitable with just one good trade every three trades.

Let’s do an exercise. Suppose a trader has 70% success on their trades and has a reward-to-risk ratio of one. Let’s call that risk R.

After ten trades, they have won 7R and lost 3R, for a total profit of 4R.

Now suppose, we plan not to take profits so soon. For reward-to-risk ratios of 3:1, and as a consequence, we end with 40% profitable trades. Let’s do the maths:

Total profitable trades: 4 -> total profit: 3X4R= 12R

Total unprofitable trades: 6 -> total losses: 6x1R = 6R

Total Profit on ten trades = 6R

Therefore, the conclusion is clear: by planning to get 3:1 reward-to-risk ratios we are 50% more efficient, even though we decrease our hit rate by 42%. Thus, traders should take care of this primary aspect of a trade and not accept trades with less than 2:1 ratios.

 

Impulsive waves

The standard technique is to enter on a break of the high or low of the lower order 5th wave. This breakout defines a point of invalidation of the current trend because the last low or high has been broken.

Fig 8 shows the complete entry setups for longs and shorts. We see that the entry is executed at a breakout of wave [v] to the upside/downside, invalidating the current trend, as it failed to make new lows/highs.

Bull and bear Diagonals

According to Frost and Prechter, a diagonal is a motive pattern, but it cannot be qualified as an impulse because it holds corrective characteristics. It’s a motive because its retracements don’t fully reach the preceding sub-wave, and the third sub-wave is never the shortest. However, diagonals are the only five-wave structures in which its fourth wave moves into the price area of wave 1, and its internal waves are three-legged structures. This pattern substitutes an impulse at the corresponding location.

Ending Diagonal

An ending diagonal is a substitution of the fifth wave, usually, when the preceding move has gone too far and too fast, according to Elliott. A small percentage of diagonals appear in C-waves also. These are weak formations. According to Frost and Prechter: “Fifth wave extensions, truncated fifths, and ending diagonals all imply the same thing: dramatic reversal ahead”.

There are three ways to set up a trade on ending diagonals. The first and most conservative is to wait for the break of wave four extreme Fig 9 – (2). You gain precision at the expense of reward-to-risk ratio. You could improve that ratio by entering the trade at (1) at the breakout of the diagonal trendline connecting 2 and 4. The third way is a combination of the former two. You start taking a fractional position at (1) and, then add to the position when it breaks levels at (2).

Trading corrections

Markets movements against the primary trend are fights between those who think that the trend is over and those that see a pullback as an opportunity to jump into the trend. This struggle makes corrective patterns a dangerous and unproductive place. My advice to inexperienced traders is not to trade corrections until you get extensive knowledge about how a particular market behaves. This market phase is like to a river crowded with thousands of crocodiles. You may be lucky and cross the river, but you’re risking losing one leg or both.

A corrective phase is more complex than an impulsive phase; it unfolds slowly and depicts a noisy, random, path, taking diverse shapes such as flats, triangles zigzags or a combination. They are erratic, time-consuming, and misleading.

There are situations where the channel within which the corrective wave moves is wide enough so that the potential reward is high enough. Under those circumstances, it may be beneficial to move to a shorter timeframe to detect the right entry points.

Corrective processes show two classes. Sharp corrections and sideways channels. No more explanation needed. Sharp corrections move prices to correct a substantial part of the movement of the main trend, while sideways channels depict lateral movement that, while moving prices back the from the previous trend ending, it contains legs that carry price back to, or even beyond its initial level producing a kind of lateral channel.

There are three main categories: Zigzags, Flats and Triangles.

ZigZags

A single zig-zag in a bull market is a simple three-wave (A-B-C) pattern that pulls back some of the gains of the primary trend (fig 10, left side). In bear markets, corrections are a kind of bear traps that drive prices up in the opposite way (fig 10, right side).

On occasions, double or triple zigzags occurs. In that case, according to Frost and Prechter, zigzags are separated by an intervening “three”. These formations, still according to Frost and Prechter, are analogous to the extension of an impulse wave but are less common.

Zigzag setups for bull and bear markets are shown in Fig. 12. These setups profit from an entry at the extreme of a c-wave and assuming this is the conclusion of the correction and that a new wave in the direction of the main trend is starting.

We have three ways to trade that, as happened in ending diagonals. The more aggressive style, presenting the best reward for its risk, is taking the trade at point (1) of fig 12, which corresponds to the breakout of the [iv] sub-wave.  A more conservative approach is to wait for the breakout of the [c] wave, which also corresponds to the extreme of wave B (Fig. 12, point (2)). Finally, we could take a medium-risk approach by opening with a fraction of the total risk at (1) and take the rest at (2).

Flats

A flat is a correction that differs from a zigzag in that its sequence is a 3-3-5 wave. The reason is that the first wave A lacks the strength to create five sub-waves. Then B-wave finishes near the starting of A and then C, having five sub-waves that generally, ends slightly below A, almost drawing a double bottom or top.

The final wave of a flat wave is a 5-wave pattern. Therefore, we can apply the setup used for the 5th wave (Fig. 8). That means trading the breakout of the [iv]sub-wave. Fig 14 shows the configuration for bull and bear markets.

 

Triangles

A triangle is a price pattern reflecting doubts and a balance of opinions between market participants. This pattern subdivides into 3-3-3-3-3 sub-waves, labelled A, B, C, D, and E. A triangle is outlined when connecting A and C, and B and D. It’s usual for Wave E to undershoot or overshoot the A-C line.

There are three triangle varieties: Contracting, barrier and expanding.

The safest entry waits for wave [c] wave to be broken. More aggressive entries are not recommended because triangles are very deceptive, and sometimes some formation that seems a bullish continuation pattern actually could become a bearish triangle.

 

This completes this basic guide to Elliott Wave trading. In upcoming articles, we will examine real chart examples of the setups sketched out in this document.

 


 

References:

Visual guide to Elliott Wave Trading, Wayne Gorman

Elliott Wave Principle: Key to Market Behavior, Robert R. Prechter Jr.; A. J. Frost.

 

© Forex. Academy

Categories
Forex Educational Library

How to Trade Using the RSI

Introduction

In 1978, J. Welles Wilder Jr published the Relative Strength Index (RSI) in the book “New Concepts in Technical Trading Systems.” Wilder describes the RSI as “a tool which can add a new dimension to chart interpretation.” Some of these interpretations are tops and bottoms identification, divergences, failure swings, support and resistance, and chart formations.

The Relative Strength Index is probably the most popular indicator used by professional and retail traders. It’s an oscillator which moves in a range between 0 to 100. A. Elder describes the RSI as a “leading or coincident indicator – never laggard.” In this article, we will show these different ways to use the RSI.

Tops and Bottoms Identification

The theory about this indicator states: “when the RSI goes above 70 or below 30, the Index will usually top or bottom out,  before the real market top or bottom, providing evidence that a reversal or at least an important reaction is imminent”. Some traders have modified these levels to 80 – 20.

The basic trading idea is:

  • Buy zone: when the RSI is below the 30 (or 20) level.
  • Sell zone: when the RSI is above the 70 (or 80) level.

A trading system based on this interpretation is an easy way to lose money. The following example shows what I mean:

Relative Strength Index (RSI)

Figure 1: Tops and Bottoms signals

Source: Personal Collection

 

In figure 1, an example of a trading system based on Top and Bottoms is shown, with RSI levels of 30 and 70 (or 20 and 80) as entry signals.  To make it short, most of the time the entry signals were false and didn’t allow catching significant trends.

Divergences are the most popular use; Wilder describes the divergence between price movement and RSI as a “very strong indication that the market turning point is imminent.” Divergence takes place when the price is increasing, and the RSI is flat or decreasing (this is known as bearish divergence); the opposite case happens when the price is decreasing, and the RSI is flat or increasing (bullish divergence).

How to trade using the Relative Strength Index (RSI)

Figure 2: Divergences

 

As shown in Figure 2, the divergences are a price weakening formation. That does not mean that it’s a turning point or that you should position yourself in the opposite direction.

Failure Swing

LeBeau and Lucas describe Failure Swing as a formation “which is easier to observe in the RSI study itself than in the underlying chart.” A strong indication of market reversal occurs when the RSI climbs above the 30 level or plunges below the 70 level.

Failure Swing

Figure 3: Failure Swing

 

As we can see in figure 3, the failure swing is part of the divergence concept, and it only confirms that the divergence is real. But you must pay attention and be careful with the failure swing as an entry signal because it is not a rule. The potential trade requires price-action confirmation.

Support and Resistance

The theory says that “support and resistance often show up clearly on the RSI before becoming apparent on the bar chart.” Some authors use the 50 level as a support level in a bullish trend or as resistance in a bearish trend. Hayden proposes the following rules for each trend direction:

  • In a bullish trend, the RSI will find support at 40 and resistance at 80.
  • In a bearish trend, the RSI will find support at 20 and resistance at 60.

RSI Support and Resistance

Figure 4: Support and Resistance.

 

In figure 4, the RSI shows how the RSI works as support and resistance on a bearish and a bullish trend. In the bearish trend, the 60-70’s zone is acting as resistance levels and 30-20’s zone as support. In a contrarian case, during the bullish trend, 70-80’s are the resistance zone, and 40-30’s the support zone.

Chart Formations

The RSI could display a pattern similar to those present in chart formations which may not be clear on the price chart, for example, triangles, pennants, breakouts, buy or sell points. A formation breakout indicates a move in the breakout direction.

RSI Chart Formations

Figure 5: Chart Formations

 

The most common formation is the triangle as a consolidation pattern before an explosive move. However, also is common to see false breakouts before the real move (see figure 5).

RSI chart formations breakout as a trading signal:

Buy Signal: When RSI breaks above its downtrend line place an order to buy above the latest price peak to catch the upside move.

Sell Signal: When RSI breaks below its uptrend line place an order to sell short below the latest price to catch a downside breakout.

We must consider that, usually, the RSI breaks its trendline one or two periods before price does.  In this sense, it’s important to get a confirmation using price-action.

COMMENTARY

To summarize, the RSI is a popular indicator between professional and retail traders alike.  It’s characterized by being a leading indicator. While every one of those styles (divergences, failure swing, support and resistance, and chart formations) can be used independently, that’s not a powerful tool.

A more reliable way to apply the RSI is using a mix of those methods, but the main issue here is how to trade using the RSI.

Some tips to use the RSI:

  1. Determine what is the primary trend? The “big picture” of the traded market.
  2. Identify key levels (swings), divergences, failure swings, chart formations between Price and RSI. In bear markets, wait for a resistance level (60-70’s zone). In bull markets, wait for support levels (40-30’s zone).
  3. Observe price and RSI breakouts.
  4. The order could be placed at the open of the candle, or when the price reaches a specific level (limit or stop orders).
  5. The stop-loss level could be set beyond the last swing high or low, or specific number of pips away.
  6. Profit-taking, ideally, should be set, at least, at two times the distance from the entry point to the stop-loss. Another possibility is to find a key level and set it close to it if the reward is worth its risk
  7. As trade management, the use of a trailing stop should be considered.
  8. If the market moves without us, let it go. The market will provide more opportunities.

 

Trading with the RSI

Figure 6: Trading with the RSI (*)

Source: Personal Collection

 

Trading with the Relative Strength Index (RSI)

Figure 7: Trading with the RSI (*)

Source: Personal Collection

As you can see figures 6 and 7, the RSI is an indicator that does much more than an identification of overbought and oversold price levels. It helps us detecting trade opportunities, areas of movement exhaustion, confirmation of price patterns (price level failures), and chart patterns. However, RSI signals and patterns should only be used as a guide.  A relationship of those signals with the price action should always be present.

(*) This is a simulated analysis and trade application.

SUGGESTED READINGS

  • Wilder, J.W. (1978). New Concepts in Technical Trading Systems. North Carolina: Trend Research.
  • Hayden, J. (2004). RSI: The Complete Guide. South Carolina: Traders Press Inc.
  • LeBeau, Ch., Lucas, D. (1991). Computer Analysis of the Futures Market. New York: McGraw-Hill.
  • Elder, A. (2014). The New Trading for a Living. New Jersey: John Wiley & Sons, Inc.

 

Keywords:

Technical Indicators, RSI, Education.

 

©Forex.Academy

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Forex Educational Library

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

Introduction

We have already dealt, briefly, with bands and channels. On this article, we will try to develop a bit more on bands and envelopes, as it is quite important in trading.

The history of trading bands is quite long. Let’s first define what we mean by a band.  John Bollinger defines bands as bands constructed above and below some measure of central tendency, which need not be symmetrical.

We called it envelopes when they are related to the price structure, with a kind of symmetry, but not following or associated with a central point reference -for example, moving average envelopes of highs and lows.

A Brief History of Envelopes and Bands

The earliest mention, according to John Bollinger, comes from Wilfrid LeDoux in 1960, who copyrighted the Twin-Line Chart, that connected monthly highs and monthly lows. You may google “Wilfrid LeDoux Twin-line chart” to see this type of chart.

At about the same time, Chester W. Keltner published the Ten-Day Moving Average Rule in his 1960 book How to make money in commodities. Keltner computed what he called the typical price by the simple formula: (H+L+C)/3 for a given period as a center line, and a 10-day moving average plus and minus a 10-period average of the daily range.

In the 60’s Richard Donchian took another approach. He let the markets show its envelopes via his four-week rule. A buy signal happens if the price exceeds the 4-week high, and a sell signal if the price falls under the 4-week low. This 4-week rule was turned into envelopes connecting the 4-week highs and the 4-week lows.

Back in the 70’s, J.M Hurst published The Profit Magic of Stock Transactions. Mr. Husrt interest was in cycles, so in his book, he presented “constant width curvilinear channels” to emphasize the cyclic character of the stock price movements.

In the early 80’s William Smith, of Tiger Software presented a black-box system: The Peerless Stock Market Timing. The system used a percentage band based on moving averages.

Concurrently, in the early 80’s Marc Chaikin and Bob Brogan developed the first adaptive band system, called Bomar Bands. They were designed to contain 85% of the price action over the latest 12 months (250 periods). That was a significant improvement to the former bands, as the width of the band grew or shrunk depending upon the market action.

A mention should be made to Jim Yates that in the early 80’s developed a method, using the implied volatility from the options market. He determined whether the security was overbought or oversold concerning market expectations. Mr. Yates showed that implied volatility could be used as part of a framework to make rational investing decisions. The framework consisted of six zones (bands) based on the implied volatility, with a specific strategy to be followed in each band.

John Bollinger, who at that time was trading options and met Mr. Yates, took this idea in the late 80’s to find a method to automate the band’s width based on the current mean volatility. He realized that volatility was directly related to the standard deviation of prices and that this method would provide a superior way to draw its bands, which he named Bollinger bands.

Bands formed by moving averages

There are several envelope types in trading. The simplest is the moving average envelope with percentage bands, n% away from the central average (Fig 1.a), that shows a 10-bar EMA with 0.2% bands.

Usually, the beginning of a trend is pointed out by prices touching or breaking one of the bands that agrees with a new change in the slope of the moving average.

The variations on this theme are countless. We could favor the volatility in the direction of the trend by using asymmetric bands.

Envelopes on highs and lows

Another possibility is using envelopes on highs and lows (Fig 1.b). Bands will show prices contained within the band at sideway channel price movements and will indicate the beginning of a trend with a breakout or breakdown.

An uptrend is in place as long as the price doesn’t close below the channel. The reverse holds true on downtrends.

To assess if this method improves its results against entries on a usual moving average breakout, Perry J. Kaufman (see reference) did a study over a 10-year span, using both methods, in two very different markets: Eurodollar interest rates and the S&P 500.

The results he presented on page 320 of his book is shown in table 1. We may observe that this method is slightly worse for the Eurodollar market, although the 40-period variant is quite similar. Just the opposite happened in the S&P 500, where, using a 40-period envelope MA turned a losing system into a winner, and the 20-period variant has improved a lot.

The conclusion is that bands might be a worthy entry method, but we need to find the right parameters for the market we try to trade.

Keltner Channels

Chester Keltner, a famous technical trader at the time, presented his 10-day moving average rule in his 1960 book How to Make Money in Commodities. This was a simple system that used a channel whose width is defined by the 10-day range.

The algorithm to compute the channel, as is done today is:

  1. Set the MA period n. Usually 20.
  2. Set a period m to calculate the average range. Usually 10.
  3. Set a multiplier q.
  4. Compute the typical daily price: (high+low+close)/3
  5. Compute AR the n-day average of the typical daily price.
  6. Compute MA the m-day average of the daily range.
  7. Compute the upper and lower bands by performing:

Upper band = q x AR + MA

Lower Band = q x AR – MA

  1. Buy when the market crosses over the upper band and sell when it crosses under the lower band.

The original system was always in the market, but on actual computer testing, it doesn’t show any effectiveness. The system is buying on strength and selling on weakness, so it may happen that, at the time of entry, the price has already traveled too much and It’s close to saturation.

Today, traders have modified the concept to better cope with current markets.

  • Instead of buying the upper band, they sell it, and vice versa. The reasoning is selling the strength and buying the weakness because markets are usually trading in ranges. The disadvantage is not being able to catch a significant trend.
  • The number of days is modified. Some systems use a three-day average with bands around that average.
  • Many systems are using a lower timeframe for entries. If the market hits an upper band, the system waits for the shorter timeframe to hit a lower band to act.

Fig 4 shows a Keltner channel system using a 3-period channel and a 10-period moving average.

The slope of the 10-period average defines if the trend is up or down.

A Sell takes place when the price hits the upper band, and the MA is pointing down (selling at resistance).  A buy is open when the price hits the lower band, and the 10-period MA is pointing up (buy at support). As Fig. 3 shows, the system forbids trading against the trend, avoiding reactive legs.

A short exit occurs if price crosses over the 10-period MA; while a crossing below it is a sign to close a long position.

Bollinger Bands

Bollinger bands are another type of volatility band, as is the Keltner channel, but the measurement of the volatility isn’t the daily range, but the standard deviation of prices for the period in place.

John Bollinger used the 20-period standard deviation (STD), and the upper and lower bands separated 2 STD’s from a central 20-period SMA. He explains that two STD’s distance from the mean will contain 95% of t e price action and that the bands are very responsive, since the standard deviation calculation is computed using the squares of the deviations from the average, so the channel contracts and expands rapidly with volatility changes.

Bollinger bands are commonly used together with another technical study. Some people use it with RSI. But, I think there’s another technical study much better suited as its companion.

Bollinger bands with two moving regression line crossovers were introduced to me by Ken Long on a seminar that took place in Raleigh, NC, back in 2013. He calls his system the Regression Line Crossover (RLCO), but, many charting packages don’t have a native moving linear regression study, so, he presented, too, a very close alternative to it: The 30-10-5 MACD study.

Bollinger band framework

Ken Long called the ±1 bands the river. The stream of prices is represented by the dragon, a 10-period -0.2std width- Bollinger band, which he calls that way due to its shape resembling those Chinese moving dragons, so common in their celebrations. Ken uses 30-period BB, but I don’t see any gain using this period. In fact, it makes more difficult to spot sideways channels because a 30-period BB is less responsive to volatility changes, so I recommend using the standard 20-period.

The dragon moves from side to side of the river, sometimes beyond. When it crosses it and travels along the upper side, the trend is up. If it moves to the lower side and keeps moving on that side, a downward leg has started.

Sideways channels are distinguished by a shrink in volatility that is clearly visible, particularly in ±1 bands, as Fig 5 shows (1, 3, 4, and 5). Those places are excellent entry points when the dragon breaks out (4), up or down, or if it starts moving next to a riverside, as in (1 and 3). You could be able to earn your monthly pay by just trading this formation.

We should be ready to close a failed breakout, as in b, and c; and willing to reverse direction when the candle, or the dragon, cross again the river because failure to continue is a clear indication to trade the other side, although, sometimes we got fooled twice. Twice is not that much. (read my essay “Trading, a different view”)

Trends are distinguished, also by an expansion of the river and its “wetlands”. And, if the price goes away from the dragon and travels to the 2nd and 3rd lands (a and d), then the price movement is well over-extended, and, for sure, it will travel back to the mean of the river. Anyway, an automatic stop and reverse trade isn’t advisable at these points. You should carefully assess the reward to risk situation, considering that the mean of the river also moves up or down with the flow.

This two-spike pattern, at the edge of ±3 bands (a and d), is quite important, as it’s a warning that we should take profits right away, it marks the peak of the trend, at least for a while.

As said earlier, Prices, after crossing bands 2 and 3, will move back searching the mean.  Usually, this is a continuation pattern. Price goes to the vicinity of the river mean and resumes the trend, as in 2.

Trading this setup together with MACD crossovers is very revealing. When we use this framework, we know beforehand a lot about the actual state of the market. At 1 we know we cannot trade long unless the dragon shifts sides. We, know, also, that the price stream is heading to the downside and the bands are expanding. All this points to a short side entry.

At a, we knew that prices have gone crazy, and the second white candlestick confirms that the downward move has paused, at the minimum. At b, and c we got fooled twice, but, as somebody said, crocodiles live in great rivers!

We, also, know the price condition relative to a well established statistical framework that shows 98% of prices enclosed within ±3 STD bands, and 95% of them within ±2 STD bands. The framework is a visual indication of overbought and oversold, but within a framework that quantifies the concepts.

Finally, by just looking, we are able to assess the reward to risk situation anytime. If our risk is 1STD and we expect to get 2 STD’s out of a trade, based on its position on this framework, then we have a 2:1 Reward to risk situation. We don’t need to spend time calculating. It’s visual and fast. You’re able to jump faster into any trade situation!

A practical trade scalping-like exercise

Trading Bollinger bands using the MACD, this way is a beauty, as the MACD tells the direction of the trade and the Bollinger band tells where the price is, relative to its mean.

If we look at fig. 6, point 1, we observe that, on the previous bars, the price has made a bottom, by touching the -2 band four times and in the last one, a Doji was formed. Meanwhile, the MACD sang a buy, loud and clear, so it was a buying opportunity at the breakout of the highs.

Since we wanted fast and dirty profits we set our target at the piercing of the +2 band for an excellent 3:1 reward to risk trade.

The beauty of the Bollinger is that price when on a trend, tends to go back to its mean, touch it and back away from it, so at point 2 we’ll take a re-entry for a nice 2.5:1 Reward/risk trade. And this happened a third time at point 3. We were nimble, so we took no chance and close the trades, again, at the bar piercing the +2 band.

At point 4 we saw a sideways channel, that is quite observable with Bollinger bands, as noticeable shrinkage of the three bands. This is a good trade to take when a breakout occurs. So, we took it and the market fooled us for a small loss on the trade.

Anyhow, the MACD crossover and the price crossing was a sign to stop and reverse(5), and that we did! Usually, a failed breakout and, then, a breakdown with the slope of the Bollinger band turning south is an excellent entry point. This time it didn’t fail for a big trade with almost 4:1 reward/risk. We let profits run this time because the price had broken down from its support and MACD wasn’t in oversold territory. We exited when it showed signs of bottoming, as seen in the graph.

At (6) we observed another sideways channel, so we took its breakout. This time it didn’t fail, but the trend wasn’t strong enough to touch the +2 band and we sold on weakness, when MACD crossed under. We might have taken a re-entry there but the MACD wasn’t pretty, Overall, 5 winners and 1 small loser. Not bad!

Donchian Channels

Richard Donchian was a pioneer of systematic trading. He was the author of one of the first channel breakout systems. When we draw lines connecting those breakouts – highest highs to highest highs and lowest lows to lowest lows- a channel is formed.  Fig 7 shows a 20 bar Donchian breakout channel of the EUR/USD 1-hour chart.

As a new high is made the upper band moves higher, while the lower band stays at the same level, until a new 20-day low comes out, creating the stairway pattern we observe in fig 5. Sometimes, the upper band goes up while the lower goes down. This is caused by a big outside bar.

According to Perry Kaufman, in 1971, Playboy’s Investment guide reviewed Donchian’s 4-week rule as a “childishly simple” way to invest.

The Donchian trading method was as follows:

  1. Go long (and cover short positions) when the current price is higher than the high of the latest 4 weeks
  2. Sell short (and close long positions) if the current price falls below the low of the latest 4 weeks.

This system is amazingly simple and effective, even today, after more than 50 years of it being public knowledge. The Donchian 4-week rule system complies with three basic rules of trading:

  • Follow the trend
  • Let profits run
  • Limit losses

The third rule is just relatively accomplished. In high volatility markets, where the highest high is far away from its lowest low, there is a risk problem that the system doesn’t solve.  In the early years trading with this system, most systems were focused on maximum returns, without regard to risk. Now the usual way is to adapt the trade size to the market risk.

Testing the N-BAR Rule

The widespread use of software platforms for trading, incorporating some kind of programming allows for simple back-testing and optimization of trading ideas.

In the case of a Donchian system, we need just one input parameter: N, the number of bars that define a breakout. Fig 8, below, shows a naked N-day breakout system parameter optimization. In this case, we’ll use different N parameters for long trades and for the short ones.


The graph shows a relatively smooth hill, with three main tops, that graphs the Return on Account achieved by the strategy. The Return on Account is a measure that weights profits against max drawdowns, so it’s an excellent mix to choose for when optimizing our systems.

All tops seem the right places for our parameter settings, so we chose the widest one, which seems to be more stable with time. The best parameters using return-on-account as metric are Longs: 65, Shorts: 55, resulting in the following equity curve (Fig 9).

The curve is typical of breakout systems. The system is robust, but the equity curve isn’t pretty.

A Montecarlo simulation of the system (fig 10) shows its robustness, but its wild nature, as well.

Fig 11 shows the Net profit distribution, which shows an orderly shape, being its mean about $14.000 on a single contract trade, for an average max-drawdown of $5.500.

My guess was that this entry system might improve a lot if we use MAE stops (from John Sweeney’s Maximum Adverse Execution concept). Let’s see what we get by adding them.

Fig 12 and 13 show the system behavior by adding MAE-type stops together with an appropriate trail stop. No targets added as this would spoil the spirit of the system.

We observe a slightly better and tighter smoke cloud, and the distribution analysis of the profit shows a 30% increase in the mean profit.

Below the distribution analysis of max drawdowns of the original and modified systems, showing that the MAE stops not only improved profits, but it lowered the system’s average max drawdown to about $4.800, a 13% improvement.

To conclude we may assert that Donchian channel breakouts work. Its mean risk to reward is 2:1 and it depicts 38% profitable trades. It’s is a robust and reliable system, although very difficult to trade.

Diversification and risk

To overcome those long and deep drawdowns, there is just one solution: To trade a basket of uncorrelated markets with risk-adjusted position sizing, so no single market holds a significant portion of the total risk.

To show you how a basket of uncorrelated stock may reduce overall risk and smooth the equity curve, let´s discuss the concept of portfolio variance.

As a simple situation let’s consider the total variance on a 2-position portfolio, which can be calculated using the following equation:

𝜎2 = w1 𝜎12 + w2 𝜎22 + 2 w1 w2 𝜎1𝜎2*cov12

Where w1 and w2 are the weights for each market, and cov12 is a quantity proportional to the correlation (ρ) between those assets.

In fact, cov12 = ρ1,2 * σ1 * σ2

Then, if the covariance is zero, then the variance of a portfolio with n assets is:

𝜎2 = w1 𝜎12 + w2 𝜎22 + … + wn 𝜎n2

To observe the effect of diversification, let’s assume that we have equal weights on five uncorrelated markets with an equal risk of $10, compared to investing just one of the markets with its full $10 risk.

Thus, to spread our risk we divide our position by five on each market, therefore, now we are exposed to a $2 risk in each market. Then, the total risk would be, again, 10, if the markets were perfectly correlated with each other, as is the case of a single asset. But, if they were totally uncorrelated, the expected combined risk would be computed using the above equation:

Risk =√ (5 x 22) = √20 = 4.47

So, for the same total market exposure, we’ve lowered our risk by more than half. Of course, there are no totally uncorrelated positions in the markets, and, sometimes, all markets move in sync with each other, but this is the way to reduce risk and smooth our equity curve as much as we can: By diversifying and making sure the correlation between our assets is as low as it may possibly be.

The Turtles

The Donchian breakout system is part of the history of systems trading, and it’s the subject of an amazing story worth a Hollywood movie.

“We’re going to raise traders like they raise turtles in Singapore”, said Richard Dennis to his friend Will Eckhardt. They wanted to end a long debate about whether a trader should be borne or could be raised.

Richard Dennis believed that anyone with the proper training and coaching could become a successful trader, while Eckhardt thought a trader needed to be born with special traits. So, the Turtles were born!

The full story at the link, below:

(https://www.huffingtonpost.com/zaheer-anwari/the-turtle-traders_b_1807500.html )

Turtle soup

As Newton found out, an action carries its reaction. To profit from those foreseeable turtle breakouts the market found a solution: Turtle soup.

Larry Connors and Linda Bradford Raschke wrote a beautiful book called Street Smarts, filled with a lot of ideas to swing trade.

Two of the ideas explained in their book trade against the Turtle pattern: The main concept is: If the 20-day Donchian breakout commonly used by the Turtles is just 38% profitable, trading against it should be about 62% profitable, by detecting and profiting from failed breakouts.

The method that Connors and Rashcke propose, looks to identify those times when a breakout fails and jump aboard to catch a reversal. By the way, this strategy can be traded in all markets and time frames.

The Turtle Soup rules for long positions (the inverse goes for short positions):

  1. The market must make a 20-period low. The lower the better
  2. The previous low must have happened four periods earlier
  3. After the market fell below the 20-period low, we place an entry buy stop 5 ticks above the previous day low.
  4. If the buy stop is filled, buy a stop-loss some tics under the current period low.
  5. Use trailing stops, as the current position is moving profitably.
  6. Re-entry rule: if you’re stopped out, you may re-enter at your original entry price if this happens in the next two bars.

Turtle soup plus one

This strategy is identical to the Turtle Soup, except it happens one day or bar later.

This strategy is more conservative, as it waits for the current bar to end, and sets the buy stop at the same place, but one bar later.

To show that two radically different ways to trade are both valid, I’ve tested this strategy. Let’s see how it behaves.

As we observe in Fig 15, the strategy is about 44% percent profitable, higher than a Donchian breakout, but far away from the theoretical 62%. Anyway, this strategy is very good, its equity curve( fig 16.b) nicer than the Turtles, and its Montecarlo cloud (fig 16.a) much thinner than the one shown in the original Turtle strategy, a sign that the variance of results is much better and more adapted to swing and day-trading. This is in agreement with its drawdown, which is more than 50% smaller than that on the Turtle strategy.

But a word of caution here. The red Montecarlo line in fig 16.a is an equity path with a segment depicting a large drawdown. The corollary here is, even using a smoother strategy, we need to have the psychological strength to accept such drawdown. This also proves that diversification is key in reducing market risk.

 


References:

John Bollinger on Bollinger Bands, John Bollinger

Ken Long Seminar on RLCO framework

Trading Systems and Methods. Fifth Edition, PERRY J. KAUFMAN

The Ultimate trading guide, John R. Hill, and George Pruitt

Quantitative trading strategies, Lars Kestner

Street Smarts, Larry Connors, Linda Raschke

Parameter testing and graphs, including Montecarlo analysis, was done in a Multicharts 11 Trading Platform.

©Forex.Academy
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Forex Educational Library

Forex Designing a Trading System (I) – Introduction to Systematic Trading

Trade and money

Trade is a concept that began with the advent of the Homo Sapien, some 20K years back. People, back then, traded their spare hunting pieces for new arrows, spears, or something else he had no time to make himself because he was hunting mammoths.

So, the first questions about what a fair deal was, and, also, how to measure and count things, began.

Trade and agriculture were significant factors that drove the Cro-Magnon men from the caves into civilization.  Everyone started specializing in what they were good at, and people had time to think and test new ideas because they didn’t need to spend time hunting.

Trade brought accounting, the concept of numbers and, finally, mathematics. Ancient account methods were discovered more than 10k years ago by Sumerians in Mesopotamia (the place between two rivers). Also, Babylonians and Egyptians gave value to accounting and measuring the results of their work and trade activities.

Sumerians were the first civilization where agricultural surpluses were big enough that many people could be freed from agricultural work, so, new professions arose, such merchants, home builders, book-keepers, priests, and artists.

The oldest Sumerian writings were records of transactions between buyers and sellers. Money started being used in Mesopotamia as early as 5,000 B.C.  in the form of silver rings. Silver coins were used in Mesopotamia and Egypt as early as 2,600 B.C.

Accounting and money are interlinked. Money was (and still is) the standard way to define the value of products and services, accounting is the method to keep track of earnings, loses and costs and evaluate the use of resources and time.

Currency trading is nothing but a refinement of the concept when several types of currencies are available in an interlinked civilization. Currency trading is the way to search the fair value of currency in relation to other currencies. To traders, accounting is the way to measure the properties and value of their trading system.

Automated versus discretionary

There are several reasons why we’ll need an automated trading system. First of all, people always trade using a system, even when they think they don’t. People trade their beliefs about the market, so their system is their beliefs.

The problem with a system based on just beliefs is that, usually, greed and fear contaminate those beliefs, and, thus, the resulting system behaves like a random system with a handicap against the trader.

Facts

Economic information translates gradually to price changes. Future events aren’t instantly discounted on price.  This is the reason for the existence of trends.

Leverage produces instability in the markets because participants don’t have infinite resources to hold to a losing position. That’s one reason for the cyclic nature of all markets and their fat tail probabilistic density distribution of returns.

There is a segmentation of participants by their risk-taking potential, objectives, and time-frames

The market reacts to new strategies. A new strategy has diminishing returns as it spreads between market participants.

The Market forgets at a long timescale. The success rate of market participants is less than 10%, so there is a high turnover rate. A new generation of traders rarely learn the lessons of the previous generation.

There is no short-term link between price and value.

The market as a noisy structure

All these facts make the markets chaotic, with a fractal-like structure of price paths, a place with millions of traders trading their beliefs, but everyone with a different timeframe and expectations.

This is ok, as no trade is possible if all market participants have the same viewpoint, but the result of hundreds of thousands of beliefs and viewpoints is that the market is as noisy as a random coin flip, as we observe in Fig. 1, reproducing three paths with 200 coin-flip bets, that closely resembles the paths of a currency or futures market.

Contradictory strategies may be both profitable or both losers

On my article about trading using bands, profitable trading VII, I’ve described two totally opposed systems: one was a Donchian breakout system, and the other was The Turtle Soup plus one. Both made money and both traded opposite to each other. That shows that opposing beliefs produce profitable systems.  Trading is not a competition to decide who’s right and who’s wrong. Trading is a business, and the goal of a trading system is to make money, not being right. In fact, none of these two systems were right even 50% of the time, but both were profitable.

Some time ago I developed a mechanical system and was so wrong that I saw almost a continuous downward equity curve. Nice! I thought. This system is so bad that if I switched it from buy to sell and vice-versa it might result in a great system!

Wrong! The reverse system was almost equally bad. That’s the nature of the markets. Nothing is easy or straightforward.

Too much freedom is dangerous

The marketplace is an open environment where a trader can freely choose entry time, direction, the size of her trade and, finally when to exit. No barrier nor rule forces any constraint on a trader. Such freedom to act is the difference between trading and gambling, but it’s a burden to discretionary traders, especially new to this profession because they tend to fall victim to their biases.

The main biases that a novel trader suffers are two: The need to be right and the belief in the law of small numbers. These two biases combined are the main culprits for the trader’s bias to take profits short and let losses run. The need to be right is also the culprit for the trader’s inclination to prefer high-frequency of winners instead of high-expectancy systems. For more on this read my article Trading, a different perspective.

To counteract this unwanted behavior, we’d need to restrict the trader’s freedom by forcing strict entry and exit rules that guarantee a proper discipline and ensure the expected reward to risk, and, at the same time, avoiding emotionally driven trades.

Discretionary versus systematic

The probability of a discretionary trader to succeed is minimal, mainly because, without a set of rules to enter and to exit, the trader immediately fall into the trap of the law of small numbers and starts doubting his system, usually with a substantial loss, as a consequence of considerable leverage.

Most successful traders develop and improve a trading strategy using discipline and objectivity, but this cannot be qualified as a systematic system because its rules are based on their beliefs about the state of the market, their mental state, and other unquantifiable factors.

A systematic trading approach must, conceptually, include:

  • Entry and exit rules should be objective, reproducible, and solely based on their inputs.
  • The strategy must be applied with discipline, without emotional bias.

Basically, a systematic strategy is a model of the behavior of one or several markets. This model defines the decision-making process based on the inputs, without emotional or belief content.

Trading can only be successful using a systematic strategy. If a trader does not follow one, trades will not be executed consistently, and there will be the tendency to second-guess signals, take late entries and premature exits.

Personal adaptation

Developing our own trading system not only gives us confidence in its results, but we’d be able to adapt it to our personal preferences and temperament. We don’t like suits that don’t fit well. A system is like a suit. A perfectly good system for one trader might be impossible to trade for another trader. For instance, a trader might not be comfortable trading on strength while another one cannot trade on weakness. A trader may hate the small losses produced by tight stops, so he favors a system with wide stops. That’s why we need to adapt the system to fit us.

The need to measure and keep records

Measurements allow distinguishing good systems from bad ones. There are several parameters worth measuring, that, later, will be dealt with, but the final objective of measurements is to determine if the trading idea behind the system is worthwhile or useless.

Measurements allow finding where the trading system is weak and optimizing the inadequate parameter to a better value. For instance, we might observe that the system experiences sporadic large losses or that it faces too many whipsaws. Measurements allow searching the sweet spot where stops do its duty to protect our capital while preserving most of the profitable trades.

When the system is already trading live, we might use measurements to adapt it to the current conditions of the market, for example to an increase or decrease of volatility. Measurements help us detect when a system no longer performs as designed, by analyzing the current statistical performance against its original or reference.

Discretionary strategies allow measurements, as well, and, sometimes help to improve a particular parameter, as well, particularly stop-loss position, but, how can this help with entries or exits if they are discretionary or emotionally driven?

Measurements, finally, will help us assess proper risk management and position sizing, based on our objectives and the statistical properties of the developed system. This concept will be developed later on, but my previous article Trading, a different perspective, mentioned above, deals with this theme.

Information

In the discretionary trading style the forex information is categorized into the following areas:

  1. Macroeconomic
  2. Political
  3. Asset-class specific
  4. News driven
  5. Price and volume
  6. Order flow or liquidity driven

In the systematic trading style the information is taken from Price and volume, although lately, some systems are also using sentiment analysis, by scanning the social networks (especially Twitter) and news, with machine learning algorithms. Order flow is left to systems designed for institutional trading because retail forex participants don’t have this information.

In this context, systematic trading simplifies information gathering, by focusing mostly on price and its derivatives: averages and technical studies.

Key Features of a sound system

The essential features a system must accomplish are:

Profitability: The model is profitable in a diversified basket of markets and conditions. To guarantee its profitability over time, we should add another feature: Simplicity. Simple rules tend to be more robust than a large pack of rules. With the later, often, we get extremely good back-tested results but this outcome is the result of overfitting, therefore, future results tend to be dismal.

Quality: the model should show a statistical distribution of returns differentiated from a random system. There are several ways to measure this. The Sharpe Ratio and the Sortino Ratio are two of them. Basically, quality measures a ratio between returns and a measure of the variation of those returns, usually this variation is the standard deviation of returns.

Risk Management and position sizing algorithms: Models are executed using position sizing and risk management algorithms, adapted to the objectives and risk tastes of the trader.

It is desirable that the algorithm for entries and exits be separated from risk management and position sizing.

Sharpe Ratio (SR) and other measures of quality

Sharpe Ratio

Sharpe ratio is a measure of the quality of a system, and is the standard way for the computation of risk-adjusted returns.

SR =ER/ STD(R)

SR = Sharpe ratio

R = Annualized percent returns

ER = Excess returns = R – Risk-free rate

STD = Standard deviation

Sortino Ratio

The Sortino Ratio is a variation of the Sharpe Ratio that seeks to measure only the “bad” volatility. Thus, the divisor is STD(R-) where R- is linked solely to the negative returns. That way the index doesn’t punish possible large positive deviations common in trend following strategies.

Sortino Ratio = ER/SRD(R-)

Coefficient of variation(CV)

The coefficient of variation is the ratio of the standard deviation of the expected returns (E), which is the mean of returns, divided by E. It’s a measure of how smooth is the equity curve. The smaller the value, the smoother the equity curve.

CV = STD(E)/E

SQN

The inverse of CV multiplied by the square root of trades is another measure of the quality of the system. It’s a measure of how good it is in comparison with a random system.

SQ = √N x E/STD(E)

Another, very similar measure of quality comes from Van K. Tharp’s SQN:

SQN = 10*E/STD(E), if the number of samples is more than 100 and

SQN = SQ if the number of samples is less than 100.

The capped SQ value allows comparing performance when the number of trades differs between systems.

Calmar Ratio

CR = R% /Max Drawdown%

It typically measures the ratio over a three year period but can be used on any period, and it’s mental peace index. How stressing the system is, compared to its returns.

CR shrinks as position size grows, so it can be a measure of position oversize if it goes below 5

Defining the parts of the problem

To finally produce a good trading system we need to identify, first, the elements of the problem, and at each one of them find the best solutions available. There are many solutions. There’s no question of right or wrong. The optimal solution is the one that fit us best.

1.    Identify the tradable markets and its features

The forex market is composed of seven major pairs and 16 crosses. The trader should decide about the composition of his trading basket in a way to minimize the correlation of the currently opened trades.

Liquidity is an important factor too. Especially noteworthy is to detect and avoid the hours when liquidity is low, and define a minimum liquidity to accept a trade.

Volatility is also necessary information that needs to be quantified. Too much volatility on a system designed in less volatile conditions may fail miserably. Especial attention to stop placement if they don’t get automatically adjusted based on the current volatility or price ranges.

We should be careful with news-driven volatility. We must decide if we trade that kind of volatility or not, and, if yes, how to fit that into our system.

2.    Identifying the market condition

A trading signal works for a defined market condition. A trend following signal to buy does not work in sideways or down trending markets.

Identify regression to a mean. Usually, mean-reverting conditions happen in short timeframes, due to the spread of trading robots, liquidity availability, and profit taking. Regression to the mean markets merits special entry and exit methods, using some kind of bands or channels, for instance.

Identify oversold and overbought: it is crucial to detect overbought and oversold conditions to avoid trades when it’s too late to get in.

Finally, we must find a way to include all this information in the form of a set-up or trading filter.

3.    The concept and yourself

There are lots of ways to trade a market, but not every one of them will fit all traders. An example of a tough system for myself would be the Donchian breakout system. A robust and simple trend following system, but I know I wouldn’t be comfortable with 35% winners because I know that this means 12% chance of having a streak of 5 losers.

Therefore, to know what fits you, you should try to know yourself and your available time for trading.

Conceptually there are two kinds of players: Those who need frequent small gains and accepts sporadic substantial losses (premium sellers) and those who are willing to pay insurance for disasters, taking periodic small losses in search of large gains (premium buyers).

A premium seeker prefers a hit-and-run style of trading: scalping, mean-reverting, swing trading, support- resistance plays, and similar strategies. A premium seeker has a negatively skewed return distribution, as in Fig. 2:

A premium buyer is a trend follower, an early loss taker, a lottery ticket buyer, a scientist experimenting in search of the cancer cure. He is willing to be wrong several times in a row, looking for the big success: When he finds a trend, he jumps on it with no stops. If proven right, he adds to the position, pyramiding, as soon as new profits allow it. A premium buyer has a positively skewed return distribution, as in Fig. 3:

We notice that the most psychologically pleasing style comes from premium-sellers. The problem with this trading style is that it is not insured for the black-swan-type of risks. He is the risk insurer!

The premium buyer is like a businessperson. A person who is willing to assume the cost of the business for a proper reward. His problem is that he must endure continuous streaks of small loses.

An early loss taker is against the crowd instinct to take profits early, a habit with a negative expectancy, so it pays extra returns to be contrarian.

There is a mixed style where reward to risk is analyzed and optimized. It uses stop protection, while the percentage of winners is enhanced using profit targets.

The main concept for a sound system, in my opinion, is to make sure our distribution of returns has a positive skew. That can be accomplished if we make sure our system has a mean reward-to-risk ratio higher than 1:1, preferably greater than 2:1 but never less than 1:1, and by setting profit targets in tune with the market movements – placing them near resistance or support, and using trail stops.

4.    The law of active management

The Fundamental Law of Active Management was developed by Grinold and Kahn to measure the value of active management, expressed by the information ratio, using only two variables: Manager skill IC and the number of independent investment opportunities N.

IR = IC x √N

If two managers have the same investment skills but one has a more dynamic management, meaning N is higher than the other manager, its return will outperform the less dynamic manager.

This formula can be used in trading strategies, as well:  On two equally smart strategies, the one with more frequent trading will outperform the other. There’s a limitation, though, that this formula doesn’t address: The cost of doing business is more significant the higher the frequency of trading.

5.    Timeframes: Fast vs Slow

The trader’s available daily time has to be considered too. Does the trader have time to be on the screen the whole day or are they busy during work hours, hence, only able to dedicate just a couple of hours at noon to trading.

Unless the trader is willing to use a fully automated system, the time available to them dictates the possible timeframes. A trader who’s busy all day cannot trade signals that show on 1-hour timeframes but is instead forced to focus on swing trading signals that can be analyzed at noon. A full-time trader has all available time-frames at their disposal.

Well summarize here the classification made by Robert Carver on his book Systematic Trading:

·      Very Slow (average holding period: months)

Very slow systems tend to behave like buy and hold portfolios. Trading rules tend to include mean reversion to very long equilibrium such as relative value equity portfolios, that buy on weakness and sell on strength.

As a result of the law of active management, returns from dynamic trading diminish, the lower the trading frequency. Therefore, at large holding periods, the return tends to be poor, unless the skill at timing the market were top notch.

·      Medium (average period hours to days)

The law of active management gives us a clue that this timeframe gets more attractive results than a longer time-frame.

It’s adequate to part-time traders that can do swing trading, working in the evening, searching for signals to be used in hourly and daily charts. From a Forex perspective, these medium-speed timeframes are less crowded with traders. Therefore, strategies may work better than shorter timeframes.

·      Fast( from microseconds to one day)

The Sharpe ratios could be very high in these timeframes, an important portion of the raw returns ought to be spent on costs (commissions and spreads).

6.    Risk

Risk is a broad concept. There are several kinds of risk. The first type of risk is the trade risk. The risk you assume on a particular trade. That’s the monetary distance from entry to your stop loss multiplied by the number of contracts bought or sold.  It’s easy to assess and measure.

The second type of risk is the Potential drawdown a system may experience. This kind of risk is dependent on position size and the percent losers of the system, therefore, we can estimate it with certain accuracy.

Risk can be defined as the variability of results. It’s a statistical value that measures the mean value of the distance between results, and the mean of results and is called standard deviation. The point is that market volatility is shifting and, further, it’s different from asset to asset.

If a trader has a basket of tradable markets, there might happen that one asset is responsible for 60% of the overall volatility on her portfolio, because the position size in that particular asset is higher, compared with others or because its volatility is much higher.

The best way to reduce the overall risk is through diversification and volatility standardization.

Diversification:

To reduce overall risk, there is just one solution: To trade a basket of uncorrelated markets and systems, with risk-adjusted position sizing, so no single market holds a significant portion of the total risk.

Below is the equation of the risk of an n-asset portfolio when there’s no correlation:

𝜎 =√ ( w1 𝜎12 + w2 𝜎22 + … + wn 𝜎n2)

where 𝜎I is the risk on an asset, and wi is the weight of that asset on the basket.

Let’s assume that we hold a basket of equal risk-adjusted positions in 5 uncorrelated markets with a total risk of $10. Therefore, we have a $2 risk exposure on each market, and the correlated total risk would have been 10. But, if the assets were totally uncorrelated, the expected combined risk would be computed using the above equation, then:

Risk =√ (5 x 22) = √20 = 4.47

So, for the same total market exposure, we have lowered our risk by more than half.

Volatility standardisation

Volatility standardization is a powerful idea: It is the adjustment of the position size of different assets, so they have the same expected risk.

This allows having a balanced portfolio where each component has a similar risk. It means, also, that the same trading rule can be applied to different markets if applied with the same standardized risk.

Leverage

The forex industry is attractive for its huge amount of allowed leverage. A trader is allowed to control up to one million euros with a modest 10,000 euro account. That is heaven and hell at the same time. If a trader doesn’t know how to control her risk, he’s surely overtrading.

I recommend reading my small article on position size, but for the sake of clarity, let’s do an exercise.

Let’s compute the maximum dollar risk on a $10,000 account and a maximum tolerable drawdown of 20%, assuming we wanted to withstand 8 consecutive losses.

According to this, we will assume a streak of eight consecutive losses, or 8R.

20% x $10,000 = $2,000 this is our maximum allowed drawdown, and will be distributed over 8 trades, so:

8R = $2,000 = $250, therefore:

Our maximum allowed risk on any trade would be $250 or 2.5% of our running account.

By the way, that value is a bit high. I’d recommend new traders starting with no more than 0.5% risk while beginning with a new system. It’s better to pay less while learning.

The second part of the equation is to compute how many contracts to buy on a particular entry signal.

The risk on one unit is a direct calculation of the difference in points, ticks, pips or cents from entry point to the stop loss multiplied by the minimum allowed lot.

 

Consider, for example, the risk of a micro-lot of the EUR/USD pair in the following short entry:

 

Size of a micro-lot: 1,000 units

           Entry point: 1.19344

              Stop loss: 1.19621

 

We see that the distance from entry to stop loss is 0.00277

Then, the monetary risk for one micro-lot: 0.00277 * 1,000 = € 2.77
Therefore, the proper position size is €250 /€2.77= 90 micro-lots, or 9 mini-lots

Using this concept, we can standardize our position size according to individual risk. For instance, if the unit risk in the previous example were $5 instead, the position size would be:

PS = €250/5 => 50 micro-lots.

That way risk is constant and independent of the distance from entry to stop.

Finally, it’s better to use a percentage of the running capital instead of a fixed euro amount, because, that way, our risk is constantly adapted to our current portfolio size.

7.    The profitability rule

A trading system is profitable over a period if the amount won is higher than the amount lost:

∑Won -∑Lost >0    (1)

The average winning trade is the sum won divided by the number of winning traders Nw.

W =∑Won / N (2)

The average losing trade is then:

L =∑Lost / NL,  (3)  where NL is the number of losing trades.

Thus, equation (1) becomes:

WNwLNL, > 0    (4)

The number of losing trades is the total number of trades minus the winning trades:

NL = N – Nw     (5)

Therefore, substituting (5) and dividing by N, equation (4) becomes:

WNw / N – L(N-Nw) / N > 0     (6)

If we define P = Nw / N,  then (N-Nw) / N = 1-P,  and  (6) becomes:

WP– L(1-P) > 0   ->    W/L x P – (1-P) > 0    (7)

Finally, if we define a Reward to risk ratio as Rwr = W/L  Then we get

P > 1 / (1+ Rwr)     (8)

Equation 8 is the formula that tells the trader the minimum percent winners required on a system to be profitable if its mean reward to risk ratio is Rwr.

Of course, we could solve the problem of the minimum Rwr required on a system with percent winners greater than P.

Rwr  > (1-P)/P     (9)

8.    Parts of a trading system

In upcoming articles, we’ll be discussing all parts of a trading system extensively. Here we are just sketching a skeleton on which to build a successful system.

A trading system is composed of at least of a rule to enter the market and a rule to exit, but it may include the following:

  • A setup rule: A rule defines under which conditions a trade is allowed, for example, a trend following rule.
  • A filter rule: A filter to forbid entries under certain conditions, for example, when there is low volume, or high volatility, the overbought or oversold conditions are reached.
  • An entry rule, defined with price action, moving averages, MACD, Bollinger Bands and so on.
  • A stop-loss, to limit losses in case the trade goes wrong. Optionally a trailing stop.
  • A profit target: Profit target may be monetary, percent, based on supports or resistances, on the touch of a moving average or any other.
  • A position sizing rule. As mentioned before, it should make sure the risk is evenly and correctly set.
  • Optionally, A re-entry rule. The rule decides a re-entry if the stopped trade turns again on the original trade direction.

9.    Chart flow of the development of a trading system

In the next chapters of this series, we will develop on every aspect sketched in this introductory article.

 

 


References:

Professional Automated Trading, Eugene A. Durenard

Systematic Trading, Robert Carver

Profitability and Systematic Trading, Michael Harris

Computer Analysis of the Futures Markets, Charles LeBeau, George Lucas

Building Winning Algorithmic Trading Systems, Kevin J. Davey

Categories
Forex Educational Library

Is The Trend Really Your Friend?

Introduction

In this document, we will discuss the principle of Trading with the trend.  

  1. We will dissect the “Trade with the trend” discussion in:
  2. What is a trend
  3. Methods traders use to identify and trade a trend
  4. Time-frames and risk
  5. Conclusions and criticism

1.    What is a trend

Bruce Babcock, in his classic “The four cardinal principles of trading,” states his firm belief that there must exist some price trend to profit from price movement in the markets.  Even, if somebody says he trades against the trend,” those ‘countertrend’ traders are really trend traders in a shorter time frame.

The key issue for him is whether we know what our trading time frame is, whether we have specific means of identifying the trend in that time frame.

According to Babcock, a trend seems to be some relatively persistent price movement– upward or downward- linked to a time frame.

Colin Alexander, one of his interviewees, shows the main captcha with trends: “Everybody will tell you that the trend is your friend, but unless you have a working definition of what a trend is, you have a real problem with putting the idea into practical effect. […] The practicality of using this concept requires that you have criteria for determining what a trend is for the purposes of trading.”

Also, Peter Brandt touches the point: “Trading with the trend is a wonderful idea conceptually, but it’s difficult to implement in everyday practical terms.” […] “Like everything else in trading, a trend is wonderfully identifiable in hindsight, but very difficult to grasp in real-time.”

James Kneafsey adds another bit to the puzzle. He says that, in theory, trading with the trend is a noble idea, but difficult in practice because markets are not trending all the time. He states that about one-third of the time markets are in choppy mode or minor trend and another third of the time there is a neutral or sideways move.

Glen Ring says that while trading with the trend is important, it’s not the key. It’s vital to adapt your trading style to your own personality, but the most forgiven way to trade in the way to expertise is with the trend, he said.

2.    Methods traders use to identify and trade a trend

The first thing a trader needs to do, then, is to find a methodology for a definition of trend that fulfils its purpose, for him, as trading signal at the earliest possible moment (usually when the eye still doesn’t see it) with a compromise between reliability and risk size; or, more precisely, between success rate and risk to reward ratio.

  • Single moving average

Using a single moving average, a trading signal appears when the price crosses over/under the average. Another method is to wait until the average points up/down.

Good MA periods to define a trend range from 20-60 bars.

  • Two or more moving averages

Two or more moving averages

In this case, there are two variations:

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

Typical periods are 10-25 for the fast MA, and 30-60 for the slower one.

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

Moving averages on different timeframes

  • A pattern of higher highs and higher lows is a pattern of an uptrend while lower highs and lower lows reveal a downtrend.

higher highs and lows

 

  • Breakouts of a trading range

Oscillators, such as Stochastics or Williams %R, are used by some of those traders to tighten the trigger point to a lower risk. The problem with breakouts is the risk.

If we look at the above figure, it’s evident that going long at breakout point is riskier than going long at the bottom of previous retracements, as the distance from the entry to the level where the trend is negated is rather high (entry:108335, stop: 1.04495).

The way traders deal with this is to move to a lower time frame, in this case, intraday (hourly or smaller), and look for early signs of a breakout. The other way is using an oscillator that tells the trader the market is in oversold condition (in this case it’s the beginning of the EUR/USD uptrend) but ready to resume the main trend. Here the %R is beginning to move up (see below), breaking up the -80 level, hinting a short-term leg up.

Those points are good entries, with much less risk – about 50% of the breakout risk- that may be used to double the position size for the same dollar risk. It’s useful, also, to add to the position.

 

Breakouts of a trading range

 

  • The usage of Stochastics as a proxy for moving averages:

Michael Chisholm says he prefers the use of three stochastics in three timeframes: daily, weekly and monthly. When all of them are in agreement “that’s a powerful indicator”. The use of Stochastics, he says, allows him to grasp the different market cycles better.

The usage of Stochastics as a proxy for moving averages:

 

  • Trend lines: the use of trend lines at the highs or lows of the price formation.

Trend lines: the use of trend lines at the highs or lows of the price formation.

 

 

  • Linear regression channel.

Sometimes there’s no easy way to see where the price is moving. The use of the linear regression channel may help there.

Linear regression channel

In cases such as this, when there is a downward channel, the use of an oscillator is key to profiting from sub-trends, as we see in the above figure. This kind of trade uses the old principle of “buying the dips and selling the rallies.”

We may observe, also that a 50-day MA is rather useless. A shorter 10-day MA helps, though, because the channel is wide enough.

3.    timeframes and risk

The selection of the timeframe should be part of the process of money management, rather than just an entry rule.

Each chart pattern has an objective and stop-loss point where we know the pattern failed: That is the exit point on a losing trade. If the potential loss is higher than allowed by the account size, this particular time-frame isn’t tradable, or we should trade smaller. Then, a shift to a shorter timeframe, with lower dollar-risk, allows a trader to ramp up his position size.

4.    take away points

  • We need to assess the major trend direction to improve the chances of a trade being successful
  • Even if we trade counter-trend, it’s important to know the direction of the higher-order trend
  • The trend can be discovered using several methods, but the sooner we find it, the better
  • The use of oscillators helps us spot better (less risky) entry points, and also add-to-position points
  • The choice of timeframe is directly related to risk

5.    conclusions and criticism

When trading using short timeframes, it’s advantageous the use of oscillators or a trend channel to find better entry points at the end of minor corrections.

Sometimes it happens that, when a trend has been detected, the price has already traveled a long distance, reducing the Reward to risk ratio of the potential trade too much to be worth trading. The use of pivots to assess swing points may allow traders much better entry spots and profit targets.

Trend-following systems show very high Risk to reward trades (from 3 to 10), but usually, those come at the expense of less than 40% success rate. That means it’s prone to very large losing streaks (more than 5 are common, and sometimes it goes up to 20). Trend following requires a trader with a strong discipline to execute the entries and stop-loss trades; and a firm belief in the system or it will inevitably fail.

A way to deal with this is to split the trade into 3 lots, the first with a target close to the entry, the second with a target close to a resistance/support level and a third one trailed to let it run until is taken by price action.

 ©Forex.Academy