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Forex Basic Strategies

Identifying & Trading The Bullish & Bearish Gartley Pattern

Introduction

We have discussed three of the most used Harmonic patterns in the previous strategy articles, and they are AB=CD, Butterfly, and Bat patterns. In today’s article, let’s learn how to trade one of the oldest Harmonic patterns – The Gartley. Trading harmonic patterns is one of the most challenging ways to trade but equally rewarding. There are traders across the world who highly believe in these patterns because of their accuracy in identifying trading signals, and the high RRR trades they offer.

The Gartley is one of the most commonly used harmonic patterns as it works very well on all the timeframes. IT is also one such pattern that frequently appears on the price charts. H.M Gartley introduced this pattern in his book ‘Profits in the Stock Market’ in the year 1935.

This pattern is also known as the Gartley 222 pattern because H.M Gartley introduced this pattern in the 222nd page of his book. There are both bearish and bullish Gartley patterns, and they appear depending on the underlying trend of the market. The Gartley pattern is made up of 5 pivot points; let’s see what these points are in the below section.

5 Pivot Points of The Garley Pattern

Just like other harmonic patterns, H.M Gartley used five letters to distinguish the five separate moves and impulses of the Gartley pattern.

  • The letter X represents the start of the trend.
  • The letter A represents the end of the trend.
  • The letter B represents the first pullback of the trend.
  • The letter C represents the pullback of the pullback.
  • The letter D represents the target of the letter C.

Gartley Pattern Rules

‘X-A’ – This is the very first move of the pattern. The wave XA doesn’t fit any criteria, so it is nothing but a bullish or bearish move in the market.

‘A-B’ – The Second move AB should approximately be at the 61.8% level of the first XA move. So if the XA move is bearish, the AB move should reverse the price action and reach the 61.8% Fib retracement level of the XA.

‘B-C’ – The goal of the BC move is to reverse the AB move. Also, the BC move should end either at 88.6% or 38.2% Fibonacci retracement level of XA.

‘C-D’ – The CD move is the reversal of the BC move. So if the BC move is 38.2% of the AB, CD move should respond at 127.2% level of BC. If BC move is at the 88.6% level of the AB move, the CD move should be at the 161.8% Fib extension level of BC.

‘A-D’ – This is the last but most crucial move of the Gartley pattern. Once the CD move is over, the next step is to measure the AD move. The Last AD move will show us the validity of the Gartley Pattern on the price chart. The pattern is said to be valid if this move takes a retracement approximately at the 78.6% Fib level of the XA move.

Below is the pictographic representation of the Gartley Pattern

 Gartley Pattern Trading Strategy 

Trading The Bullish Gartley Pattern

In the below NZD/USD weekly chart, we can see that the market is in a clear uptrend. We have then found the swing high and swing low, which is marked by the point X & Point A. We then have four swing-high & swing-low points on the price chart that binds together to form the Gartley harmonic pattern.

Always remember that every swing high and low must validate the Fibs ratios of the Gartley pattern. These levels can be approximate as we can never trade the market if we keep waiting for the perfect set-up. There are indicators out there where the Fibonacci levels are present in them by default. We generally use TradingView, and in this charting software, the below-used indicator can be found in the toolbox, which is present on the left-hand side.

Please refer to the marked region in the chart below. The first XA leg is formed just like a random bullish move in the market. The second AB move is a bearish retracement, and it is at the 61.8% Fib level of the XA move. Furthermore, the BC is a bullish move again, and it follows the 88.6% Fib level of the AB move. The CD leg is the last bearish move, and it is respecting the 161.8% Fib level of BC.

Now we have identified the bullish Gartley pattern on the price chart. We can take our long positions as soon as the CD move ends at the 161.8% level. The next and most crucial step of our strategy is to find the potential placement of our stop-loss. The ideal region to place the stop-loss is just below point X. If the price action breaks the point X, it automatically invalidates the Gartley pattern.

However, stop-loss placement depends on what kind of trader you are. Some aggressive traders place stop-losses just below the entry while some use wider stops. We suggest you follow the rules of the strategy and use point X as an ideal stop-loss placement.

B, C & A points can be considered as ideal areas for taking your profits. We suggest you go for higher targets in the case of the formation of a perfect Gartley pattern. Overall, placing a ‘take-profit‘ order depends on your previous trading experience also. Because, if you come across any ideal candlestick patterns in your favor while your trade is performing, you can extend your profits. We can also combine this pattern with other reliable technical indicators to load more positions in our trades.

Trading The Bearish Gartley Pattern

Below is the EUR/GBP four-hour chart in which we have identified the bearish Gartley pattern. In the highlighted region, we can see the formation of the bearish XA leg like a random bearish move. The second leg is AB – a bullish retracement stopping at the 61.8% level of the XA move. Furthermore, the BC move is bearish again, and it respects the 88.6% Fibs level of the AB move. CD is the final bullish move, and it is respecting the 161.8% Fibs level of BC.

As soon as the price action completes the CD move, we can be assured that the Gartley pattern is formed on our price chart. We can also see the formation of a Red confirmation candle indicating us to go short in this Forex pair. We have taken our short positions at point D and placed our stop-loss just above point X.

We have three targets in total, and they are points B, C, and A. Within a few hours, the price action hits the B point, which was our first target. Moreover, the price pulled back at point C, but we were safe in our trade as our stop-loss was placed above point X. Our final target was at point A, which is achieved within four days.

Conclusion

The Gartley pattern is wholly based on mathematical formulas and Fibonacci ratios. Remember to take the trades only when all the mentioned Fib levels are respected. If you have no experience with harmonic patterns, you must master this pattern on a demo account first and then use them on the live markets. We are saying this because it requires a lot of patience and practice to identify and trade these patterns.

We hope you understood how to identify and trade the Gartley Harmonic Pattern. If you have any questions, let us know in the comments below. Cheers!

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Forex Basic Strategies

Trading The Bullish & Bearish Bat Pattern Like A Pro

Introduction

We have learned the importance of Harmonic patterns in our previous articles. We also understood a couple of interesting harmonic patterns – The Butterfly & AB=CD. In this article, let’s understand what a ‘Bat’ pattern is, and how to make money trading this pattern. The Bat pattern is a part of the Harmonic group, and ‘Scott Carney’ discovered this pattern in the year 2001. Out of all the patterns present in the harmonic group, Bat pattern has the highest accuracy. This pattern can be extremely profitable when traded correctly.

It works very well on all the timeframes but try not to trade it in smaller timeframes because the price in these timeframes tends to reverse quickly. The Bat pattern comes in both bullish and bearish variations and is made up of five swing points X, A, B, C, and D. In a downtrend, the appearance of a bullish Bat pattern indicates a bullish reversal. In an uptrend, the appearance of a bearish Bat pattern indicates a bearish reversal.

One of the critical characteristics of the Bat pattern is the power, speed, and strength of the reversal that occurs after the appearance of this pattern on the price chart. Fibonacci ratios are the core strength of any harmonic pattern, and thanks to the advanced technology for providing the Fibs ratios to the Bat pattern to increase its accuracy.

Bat Pattern Rules

Just like most of the harmonic patterns, the Bat pattern is a four-leg reversal pattern that follows specific Fib ratios. A proper Bat pattern needs to fulfill the below criteria.

‘X-A’ – In its bullish form, the first XA move of the Bat pattern could be any random upward move on the price chart.

‘A-B’ – For a Bat pattern to get validated, the AB leg’s minimum retracement should be 38.2% of XA leg or maximum of 50% Fib levels. Scott Carney suggests that the retracement at 50% Fibs levels increase the accuracy of the signal generated.

‘B-C’ – The BC move can retrace up to a minimum of 38.2% Fib level of AB and a maximum of 88.6%.

‘C-D’ – CD is the last move that confirms the Bat pattern. This move should be at 88.6% Fibs retracement of XA leg, or it should be between 161.8% or 261.8% Fibs extension of the AB leg.

For a bearish Bat pattern, point X should be at a significant high. Conversely, for a bullish Bat pattern, point X should be at a significant low.

Below is the pictographic representation of the Bat Harmonic Chart Pattern.

Bat Pattern Trading Strategy

Trading The Bullish Bat Pattern

In the below USD/CHF four hours chart, we can see the formation of a bullish Bat pattern. These days, on most of the trading platforms, we can find all the harmonic tools which are combined with Fib levels. These tools get extremely handy when we need to quickly confirm the pattern. We use TradingView charts, and the harmonic pattern tool can be found in the left-side toolbar.

Coming to the strategy, our starting point X was at 0.9840 from where the move has started. The price action started to counter the trend from 0.9984. Let’s consider this as our point A, and the XA is nothing but a random bullish move in the market. Now we located our first swing high, so the next step is to count the market wave movement. The AB move retraces at 38.2% of the XA move, and the BC move goes up again and retraces at 88.6% of AB. Furthermore, the market prints the last move of the pattern, which is at 88.6% level of the XA move. So now we have got all the four touch patterns for a bullish Bat pattern on the price chart.

While back-testing, we found the market blasting to the north whenever the CD move finishes at 88.6% level. This is the reason why we took the buy entry as soon as the price-action completes the CD move. Overall it was an excellent risk-reward ratio trade. Also, when the CD move touches the 88.6% Fib level, it always provides a decent risk-reward ratio. The stop-loss is placed below the ‘X,’ and take-profit can either be placed at A or C points.

Trading The Bearish Bat Pattern

Both the bearish and bullish Bat patterns have the same rules. The only difference is that it appears inversely. So in this strategy, let’s trade the bearish Bat pattern with at most accuracy.

In the below NZD/USD daily chart, we have identified a bearish Bat pattern. The very first move has started from point X and ends at point A. This can be considered as a random bearish move. The price action has then reversed back and retraced at 38.2% level of the XA move forming the AB move. The market then goes into the counter direction and forms a BC leg, which is also retraced at 38.2% Fib level of the AB leg. The last leg was the CD move, and it finished close to the 88.6% Fibs level.

These swing highs and lows confirm the formation of a bearish Bat pattern on the price chart. So when the price action prints a bearish confirmation candle, we went short in this pair. Scott Carney described the points B, C and A as the first, second, and third target respectively. We can book profit at any of these points, or we can hold for deeper targets depending on the market situation.

In this particular trade, we didn’t book profits at B or C after seeing the momentum of the price. We were sure that the price could easily reach the last target. The price action did hold at point C for a longer time, which indicates that this trade might not work. Any armature trader would have panicked and closed their trades at breakeven.

But, as mentioned, whenever an ‘almost perfect’ Bat pattern is formed, the trade will definitely work. We must be patient and confident enough to stick to the strategy. Stop-loss placement is crucial, and one thumb rule while trading harmonic patterns is to place the stop-loss just below point X.

Conclusion

In short, harmonic patterns imply that the trends can be subdivided into smaller or larger waves using which the future price direction can be predicted. These harmonic patterns only work if the fibs ratios are aligned with the pattern. Some traders do not believe the authenticity of harmonic patterns, but we assure you that you can trade these patterns confidently. This ends the discussion on the Bat pattern. Remember that this pattern provides accurate entries as well as good RRR trades compared to other harmonic patterns. In the upcoming articles, let’s discuss Gartley and Crab patterns, which are equally important to learn.

We hope you find this article informative. In case of any questions, please let us know in the comments below. Cheers!

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Forex Course

66. Pairing The Fibonacci Levels With Trendlines

Introduction

In the previous articles, we learned how Fibonacci retracements give extra confirmations while trading the support & resistance levels. We also know that Fibonacci levels can be used as a confirmation tool to trade many candlestick patterns as well. Now we shall extend this discussion and understand how Fibonacci retracements can be traded using the trendlines.

Trendlines are a crucial part of technical analysis. They are primarily used to identify trends, be it up or down. Trendlines being such an important part of trading, when combined with the Fibonacci indicator, can produce trades that have the highest probability of winning. So let us see how this can be done.

Combining Fibonacci Levels & Trendlines

In the below chart, we have, firstly, identified an uptrend and drew a supporting trendline to it. The next step is to plot Fibonacci on the chart by identifying a swing low and a swing high. The marked area shows where all our trading is going to take place and the region in which we will find our swing low and swing high.

The traditional way of selecting a swing low is when the point intersects with the trendline, just as we have done in this case (below image). The swing high will be the point where the market halts and reverses for a while.

In the below chart, we have used the chosen a swing low and swing high to plot our Fibonacci indicator. In order to combine the Fibonacci with trendline, we must wait to see if the retracement from the swing high touches the 50% or 61.8% Fib level. After touching any of these levels, if the market gives a confirmation candle, it could be a perfect setup to go long. The retracement, in this case, touches the 50% level, which coincides exactly with the upward trendline. The next and final step is to look for a confirmation candle, if any.

We have gotten a confirmation sign from the market after the second green candle closes above the 23.6% Fib level (below image). Hence traders can now take risk-free positions on the ‘long’ side of the market with a stop-loss below the 61.8% Fib level and with an aggressive target above the recent high. This trade results in a risk to reward ratio of 1.5.

We should not forget that if the retracement does not take support at the 50% or 61.8% Fib level and goes further down, breaking all the levels, it could be a potential reversal sign. Thus the retracement that is coinciding with the trendline and reacting from 50% or 61.8% Fib level is the thumb of the rule of this strategy.

The above is a more widened image of the chart shows that the market continues to trend upwards, crossing our ‘take-profit‘ area. To take advantage of the market’s trending nature, we can place a trailing stop-loss order to maximize our profits.

Conclusion

When trends start to develop in the market, one should start looking for ways to go ‘long’ or ‘short’ by using necessary technical indicators that give a better chance of a profitable trade. The Fibonacci indicator is one such powerful tool to help traders find potential entry points. We hope you understood this concept clearly. Let us know if you have any questions in the comments below. Do not forget to take the quiz before you go. Cheers!

[wp_quiz id=”64779″]
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Forex Basic Strategies

Learning To Trade The Bullish & Bearish ‘Butterfly’ Harmonic Pattern

Introduction

Harmonic patterns have always been popular among a set of traders around the world. So it is essential to learn them to have an edge over the market. There are two different types of Harmonic Patterns. The first type is external, and the second is internal. External Harmonic patterns include Butterfly and crab patterns. Whereas the internal Harmonic patterns include Gartley and Bat patterns. In today’s article, let’s discuss how to trade the Butterfly pattern profitably.

The Butterfly is both a bullish and bearish reversal pattern that falls into the category of the Harmonic group. It is developed by H.M Gartley. Scott Carney and Larry Pesavento then fine-tuned the pattern by adding the Fibs ratios. This harmonic pattern is composed of four legs, and they are marked as ‘X-A,’ ‘A-B,’ ‘B-C,’ and ‘C-D.’ The Butterfly pattern mostly appears at the end of the trend indicating a trend reversal.

By identifying this pattern on the price charts, traders can enter a trade anticipating a potential market reversal. The Butterfly structure on the chart resembles the letter’M’ in a downward trend. Conversely, in an uptrend, the pattern looks like a ‘W.’

Butterfly Pattern Rules

To confirm the appearance of the Butterfly pattern, the rules below must be met. Remember to accept the pattern even if the levels are closer to these Fib ratios. If we stick these levels only, we might be missing on well-performing trades as the setups with the exact Fib levels hardly occur.

‘X-A’ – This is the initial move of the Butterfly pattern, and in a downtrend, this leg is formed when the price drops sharply from point X to A. Likewise, in an uptrend, this leg is formed when price moves up swiftly from X to A.

‘A-B’ – The B point should retrace 78.6% of X-A leg.

‘B-C’ – The B-C move should retrace 38.2% or 88.6% of the A-B move.

‘C-D’ – The C-D move is the final and most crucial move of the pattern. If the B-C is 88.6% of the A-B, then the C-D must be reached the 261.8% extension of BC. On the other hand, if the B-C is 38.2% of A-B, then the C-D must reach the 161.8% extension of B-C.

A pictographic representation of the same is shown below.

How To Trade The Butterfly Pattern

Trading The Bullish Butterfly Pattern

The below picture is a 30-minute chart of the USD/JPY Forex pair. We have identified the Butterfly pattern and plotted Fib levels on to that. As we can see, the first X-A leg started as a random bullish move on the price chart. The second A-B bearish move retraces close to the 78.6% of the X-A move.

Furthermore, the B-C moves reach close to 88.6% of the A-B move. The last C-D bullish move reaches almost close to the161.8% of the B-C movement. So after the appearance of all the four legs, we confirm the formation of the Bullish Butterfly Pattern. Now let’s how we are going to trade this pattern.

Once the price action completes the CD move, we must wait for 2 to 3 bullish candles to take a buy entry in the USD/JPY pair. We must enter the market right after the appearance of the Green confirmation candles. As we can see in the above image, the market blasted to the north right after the appearance of confirmation candles.

Always remember that we are dealing with probabilities and not certainty while trading. So as technical traders, we must adjust according to the market sentiment. The ideal way is to exit our positions when the price approaches the level of point A. But in this particular trade, the market shows excessive volatility as we can see the appearance of a ‘three white soldiers’ candlestick pattern. As per our learnings, we know when this pattern appears, the trend is going to continue.

So we must place deeper targets in this Forex pair. That’s the reason why we didn’t book any partial profits and closed our whole position at a significant resistance area. So in any given trade, always decide your risk-management according to the market situation. Furthermore, we put the stop loss just below the X point, which is the safest position to set a stop-loss. Because, if the price breaks this point, directly it invalidates the Butterfly pattern.

Trading The Bearish Butterfly Pattern

The below image represents the 240-min chart of the GBP/USD Forex pair. We have identified the formation of a Bearish Butterfly pattern in this chart. In a downtrend, the first X-A leg started as a random bearish movement in the market. The A-B leg is a bullish move that retraces close to the 78.6% of the X-A leg. Then the third B-C movement is the bearish move again, and it retraces close to the 38.2% of the A-B move. Then finally, the C-D move happened, which completes the formation of the Bearish Butterfly Pattern.

As we can see in the above picture, the last leg retraces to the upside, and it was close to the 161.8% extension of the BC move. When the price action completes the C-D leg, it prints a couple of red confirmation candles indicating a potential market reversal. Hence in this pair, we took a sell at D point, and the stop-loss placement was just above the D point. We didn’t book any partial profit at point B or C; instead, we closed our whole position at our final target, which is point A.

When and When Not to Trade The Butterfly Pattern?

The good thing about Harmonic patterns is that they work very well in all the types of markets. They also work wonderfully in every market condition. We believe you have clearly understood that the Butterfly is a reversal pattern. We must use all of our previous learnings to win a trade. For instance, if a bullish Butterfly pattern is formed in a strong downtrend, try to avoid trading that pattern. This is because it is difficult for a single pattern to completely reverse the market trend.

If the market was in an uptrend, which is now turning into a dying channel, and if we identify a bearish Butterfly pattern on the price chart, the probability of it being an accurate trading signal is more. Sometimes we can observe the market printing a pattern within the pattern. This also increases the likelihood of our trades. For instance, we can see the formation of a ‘Three White Soldiers’ pattern (below chart) in one of the examples we discussed.

This example is not in the context of trading the Harmonic pattern as a whole but in the context of placing our take-profit orders while trading Harmonic patterns.

Alternative to Harmonic Patterns?

It is a bit difficult for new traders to learn and implement the Harmonic patterns on their trades. So, in the beginning, new traders can also use other forms of technical analysis tools to trade the market. These harmonic patterns are used by most of the professional traders in the industry as they provide an excellent risk to reward ratio. But once you gain some experience, you can try trading harmonic patterns on the demo account, and if you are confident enough, you can apply them to the live charts.

In the end, price action trading is the only tool which can be considered as a complete alternative to the harmonic pattern trading. But a large part of the traders in the industry does not know how to use price action alone to trade the market. So for them, candlestick pattern trading combined with technical indicators is the best method to trade. Overall, yes, there is an alternative to harmonic pattern trading. However, most of the traders in the market aren’t aware of it.

Bottom Line

The one main benefit of identifying and trading the Butterfly pattern is that it helps the traders to identify the top and bottom of the price action so that they can ride the whole trend. The Butterfly pattern is the easiest one in the harmonic group, which provides highly profitable trading signals. The Fibonacci extension levels are an integral part of trading the Butterfly pattern. If the Fib ratios are not attached to your pattern, make sure to add the fibs manually to your price chart so that you can visualize the pattern correctly. Best of luck!

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Forex Basic Strategies

Trading The Bullish & Bearish ‘Cup and Handle’ Pattern

Introduction

The patterns on the Forex charts occur when the price movement of an underlying asset is in the form of the shapes that we come across in daily life. These are visual patterns, and they provide a logical entry point along with appropriate stop-loss and take-profit order placements. The Cup and Handle is one such pattern; this is one of the oldest chart pattern identified by technical trading experts back in the late 20th century. This pattern is very reliable and very commonly used by traders across the world.

American trader and author ‘William J. O’ Neil’ defined the Cup and Handle pattern in his 1988 classic, “How to Make Money in Stocks.” This pattern occurs in all the types of the markets and is not confined to Forex or Stocks. We can also find this pattern in almost all of the timeframe. Most traders prefer trading this pattern on a higher timeframe. Having said that, this pattern produces reliable trading signals on the lower timeframes as well.

The Cup and Handle is a continuation pattern that occurs after the ongoing bearish or bullish trend. In an uptrend, when the price action reaches a peak point, if there is a price wave down, followed by a rally (approx. the same size of the wave down), this pattern is formed. It means that the price action has created a U-Shape or the Cup, and the Handle is for the confirmation and entering the trade. After the Cup, most of the time, price action turns sideways, or it drifts downwards that appear in the form of a handle on the price chart.

According to market situations, the Handle takes different forms. It prints in the form of a triangle, rectangle, or even congestion. The critical point for the Handle is that its extension shouldn’t be smaller than the Cup. The Handle should not even drop into the lower half of the Cup. For instance, if a cup forms between 0.1000 and 0.1100, the Handle must not go below 0.1050. Identifying the Cup and Handle pattern on the price charts is easy compared to the other patterns that we have discussed until now.

The Cup And Handle Pattern – Trading Strategy

Buy Example

The below image represents the formation of a Cup and Handle pattern on the EUR/USD 15 minute chart. The highlighted part in the below chart is the Handle, and we can see the Cup on to its left.

 

There are many different ways to enter a trade using this pattern. In this particular example, let’s learn the most common way, which is the breakout method. A lot of advanced traders prefer trading the breakouts as they are reliable and work pretty well with the Cup and Handle pattern as well.

In the above chart, we can see that we had entered the market by placing a buy order when the price broke the primary resistance line. Now we can see why breakout trading is very reliable while trading this pattern. Our take-profit order was at the major resistance area, and stop-loss was just below the Handle. Here, we have seen how to trade this pattern for intraday trading. However, if you are a swing trader who plans to hold your position for more extended targets, please check out the next example.

Sell Example

In the below NZD/CAD 15 min Forex chart, we can observe the formation of an inverted Cup and Handle pattern.

Right after the formation of the Cup, the price moved in sideways and resulted in a handle-like structure. After struggling a bit, the price broke the support line and made a new lower low. We have taken the entry in this pair after the appearance of a bearish confirmation candle. Right after our entry, we can see the market dropping down and printing a new low.

As a basic rule, the stop-loss placement was just above the Handle, and we ride more extended targets in this pair. We closed all of our positions when the market had a hard time print a new lower low. If you are a trader who likes to ride deeper targets, close your position when you see a consolidation. The reason is that a consolidation phase implies that both the buyers and sellers are strong. So at that point, it is not easy for the price to print a brand new lower low.

Limitations Of The Cup and Handle Pattern

Everything strategy or a pattern will have some limitations to it, and the Cup and Handle pattern is no exception. Market experts believe that this pattern is unreliable to trade in an illiquid market. The depth of the Cup plays a significant role in the strategy to perform. If the depth of the Cup is more, it might generate false trading signals.

This pattern can be found quite often on a lower timeframe. Most of the time, on lower timeframes, the Cup forms without the Handle. So make sure to pair this pattern with other reliable indicators or price action techniques to filter out the false signals.

Bottom Line

William O’Neil spent 20 years to broaden his views towards various patterns and ways to trade them. The Cup and Handle pattern is one of the results of all that fantastic experience. His broader view allowed him to shift his attention from the classical trading patterns to wonderful patterns like these. Remember that you need to be at least a little better than the other traders out there to ace the market.

Hence it is important to have a different point of view that millions of traditional retail traders out there. The problem with the setup is that most of the traders use a similar approach to exit their positions. The way we showed you to close the positions when the market turns into consolidation is one such creative idea that we have to follow to have an edge. All the best!

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Forex Basic Strategies

Most Profitable Ways To Trade The Triple Top Chart Pattern

Introduction

The Triple Top is a bearish reversal pattern that helps traders in identifying the peak areas of the market. This pattern occurs when the market prints three consecutive tops nearly at the same price level of any underlying asset. The areas of the touchpoints are the resistance levels, and the pullback between these points is known as the swing lows. After the third high or third touchpoint, if the price breaks the support and goes below, the pattern is said to be complete.

Traders can then activate their positions on the sell-side. Most of the traders try to be extra conservative and wait for the exact pattern to occur. But it can be challenging to find the Triple Top Reversal pattern with all the three highs at the same in size. We should always remember that the technical analysis is more of art and less of science. So even if 80% of the pattern rules are met, we can take the trades by confirming those signals with other credible technical indicators.

The Psychology behind the Triple Top Pattern

The appearance of a Triple Top Pattern implies that the buyers are slowly losing momentum in the market. It might also mean that the buyers are not willing to push the price higher. At the same time, the sellers are interested in taking the price lower. The Triple Top pattern is a way more powerful pattern than most of the other credible patterns in the market. This is because the third failed attempt of the buyers implies that the sellers are way too aggressive than the buyers. Hence we can expect stronger downward moves.

Triple Top Pattern – Trading strategy

The Triple Top pattern occurs very rarely on the higher timeframe. Even if it occurs, this pattern often takes a lot of time to develop fully. However, on an intraday timeframe, this pattern can be observed quite often.
Step 1: Identifying the TTP on a price chart

In the below AUDCHF Forex chart, we can see the market printing a clear Triple Top chart pattern.

Step 2: Entry 

The strategy is to wait for the breakdown to happen so that we can activate our short positions. On the 27th of January, we can observe the breakdown that occurred in this pair, and that can be considered as a clear Sell Signal.

Step 3: Stop-loss & Take Profit

We can activate our sell positions as soon as we see a bearish confirmation candle. We can go for two different targets in this trade. Both are at the higher timeframe’s support area. Most of the traders believe that their target must be double as compared to the size of the Triple Top pattern, but it’s just a myth. Always book the profit according to the market circumstances.

If the trend is super strong, go for the deeper targets. Contrarily, if the market momentum is fading, book the profit at any significant area. Traders who are well versed with pattern trading can add positions when the market goes back to the entry point so that they can ride the whole show again. While trading the breakout or break down patterns, always place the stop-loss near the recent low.

Triple Top Pattern + Double Moving Average

In this strategy, we have paired the Triple Top pattern with the Double Moving Average to identify accurate sell signals. A moving average will help us in identifying significant trends, trading opportunities, and entry/exit levels. Many traders believe that if they find the magic number of the period, then they can easily beat the market, but it’s not true. There are infinite numbers of periods available, and traders should practice only 3 to 4 periods, to use this indicator effectively.

Step 1: Identifying the TTP on a price chart

In the below chart, we can observe the market printing the Triple Top pattern on the NZD/JPY 60-minute Forex pair. We have applied the double MAs on to the price chart.

The traditional way to trade this pattern is to wait for the break down to happen and then go for sell just like we did in the above example. But in this strategy, let’s tweak things a bit by adding the double moving average to the plot. In this strategy, we are using the 14 and 9-period average. This strategy is purely for the intraday traders only.

Step 2: Entry, Stop-loss & Take Profit

After price action printing the third top, if we observe an MA crossover happening, we can activate our sell positions even before the breakdown. By following this approach, we get to enter the trade ahead of time, while the breakdown traders wait for the break down to activate their position. Most of the professional traders use this approach to maximize their profits.

There are many ways to close our positions. We can book profit at a significant support area. The placement of stop-loss depends on the trader’s trading style. If you are an aggressive trader, the smaller stop-loss is good. But expect more hits before the trade performs. If you are a conservative trader, use an extra spacious stop-loss.

Bottom line

A pattern is said to be paramount when it offers the best risk-reward ratio trades. Also, the pattern must have a higher probability of occurring in intraday timeframes. The Triple Top is one such pattern that offers both of these demands to every trader. Also, remember that the Triple Top is a bearish reversal pattern, so only take short positions when you see this pattern on the price charts. Apart from the ones mentioned above, there are different other ways to activate our position in the appearance of this pattern. But the above ones are the safest and most profitable ways to trade.

Try identifying and trading this pattern on a demo account before trading on the live charts. We hope you find this article informative. If you have any questions, please let us know in the comments below. Happy Trading.

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Forex Price-Action Strategies

To Maintain Better Winning Ratio, Go with A+ Entry

In today’s lesson, we are going to demonstrate an example of H1 breakout trading. In this example, the breakout candle, as well as the confirmation candle, is not the best one the price action traders like to have. Nevertheless, the price heads towards the trend’s direction nicely. In most cases, it does not happen though.

The price after being bullish gets choppy. It then makes a bearish move but upon finding its support, it produces a bullish engulfing candle. This is the strongest bullish reversal candle, which shall attract the buyers to keep an eye on this chart. Let us proceed to the next chart.

The price does not get bullish as expected. However, an inside bar means that the buyers still hold the key. The chart may produce bullish candle and end up making a breakout at the swing high. The H1-breakout traders must be waiting for a breakout here.

The next candle comes out as a bullish engulfing candle closing above the level of resistance. It is a breakout but the breakout is not explicit. If the candle closes well above the level of resistance, it would attract more buyers. Let us now wait for the confirmation candle. If the next candle comes out as a bullish candle closing well above the breakout candle, it may attract more buyers in the end.

The confirmation candle does not look very promising either. As far as H1 breakout price action trading is concerned, the buyers may trigger a long entry. Considering candles’ attributes, it is not an A+ entry though. Let us proceed to the next chart and find out what the price does.

The price heads towards the North with good bullish momentum. It takes only two candles to hit the target. As mentioned, it is not an A+ entry but the trade gets the buyers some profit. In some cases, we see that even an A+ entry gets us a loss instead.

This is how the market works. We must not lose our patience but stick with our plan. If we take such entry, we may have to encounter less momentum after triggering entry, and more losing trades. We have to have the mental strength to face such losses then. Otherwise, we may skip taking such entry. Such an entry does not always get us profit. We have demonstrated this in today’s lesson.

Another equation we should remember, if we want to take A+ entry, we get less number of entries but more consistency. On the other hand, if we take a signal as long as it meets our trading strategy requirement, we get more entries but less consistency.

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Forex Course

57. Trading Triple Candlestick Patterns – Part 2 (Reversal)

Introduction

We have discussed some of the major triple candlestick continuous patterns in the previous articles. In this lesson, let’s talk about the triple candlestick reversal patterns. Morning Star and Three Inside Up patterns are very well known as they provide some of the most profitable signals. Let’s get right into the topic.

Morning Star Candlestick Pattern

Morning Star is a bullish candlestick pattern consisting of three candles and is interpreted as a bull force. The pattern is formed following a downtrend and indicates the start of an uptrend, which is a complete reversal. After an occurrence of the Morning Star, traders seek reversal confirmation through additional technical indicators. The RSI is one such indicator which tells that the market has gone into an oversold condition and that a reversal can happen anytime.

Below is how a Morning Star Pattern looks like on a price chart

Criteria for the Morning Star pattern

  1. The first candle is a long bearish candle with little or no wicks.
  2. The second candle is a smaller bullish or bearish candle that captures the indecision state of the market, where the sellers start to lose control.
  3. The third and last candle is a long bullish candle that confirms the reversal and marks a new uptrend.

A trader must lookout for a bullish position in the Forex pair once they identify the Morning Star pattern on the charts. Another important factor for traders to consider is to pair this pattern with a volume indicator for additional confirmation.

Three Inside Up Candlestick Pattern

The Three Inside Up is also a triple candlestick reversal pattern. This pattern indicates the signs of the current trend losing momentum, and warns the market movement in the opposite direction. It is a bullish pattern that is composed of large bearish candle, a smaller candle contained within the previous candle, and then a bullish candle that closes above the second candle.

Below is the picture of how the Three Inside Up pattern would appear on a chart.

Criteria for the pattern

  1. The market should be in a downtrend with a large bearish first candle.
  2. The second candle should open and close within the real body of the first candle, which shows that sellers have stopped selling further.
  3. The third candle is a bullish candle that closes above the second candle, trapping all the short-sellers and attracting the bulls.

Traders must take long positions at the end of the third candle or on the following green candle, which provides additional confirmation. This pattern is not always reliable when used stand-alone. So there are chances that the trend could reverse once again quickly. So risk management should be in place before taking any trades. A stop-loss must be placed below the second candle, and it depends on how much risk the trader is willing to take.

Conclusion

The opposite of the Morning Star candlestick pattern is the Evening star. Even this is a reversal pattern, but it signals a reversal of an uptrend into a downtrend. Likewise, the opposite of the Three Inside Up pattern is the Three Inside Down pattern, which reverses an uptrend. Learn about more triple candlestick patterns and how to trade them. The more you research, the better trader you will be. Cheers.

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Forex Course

56. Learning The Triple Candlestick Patterns – Part 1 (Continuous)

Introduction

After acquiring a fair bit of knowledge about Single and Double candlesticks patterns, let’s now proceed and learn the Triple Candlestick Patterns. A Triple Candlestick Pattern, as the name clearly suggests, is formed by three candles. In the next couple of articles, we discuss two Continuation patterns and two Reversal patterns to understand how these patterns are formed. Also, most importantly, we will be learning how to trade these patterns as well. So in this article, we will be discussing the basic & well-known Continuous Triple Candlestick Patterns – Three White Soldiers and Falling Three Methods.

Three White Soldiers Candlestick Pattern

Three White Soldiers is a bullish triple candlestick pattern that predicts the reversal of the short term downtrend. The reversal of this short term trend leads to the continuation of the long term trend, and hence this pattern is classified as a continuation Pattern. This pattern consists of three long-bodied candles that open within the previous candle’s body and close above the previous candle’s high.

Below is how the Three White Soldiers candlestick pattern looks on the price chart

Criteria for the pattern

  1. The second and third candles should open within the body of the previous candle
  2. All three candles in the pattern should not have very long shadows.
  3. The continuation pattern is confirmed by other technical indicators such as the RSI and EMA.

Three White Soldiers pattern is used by traders for both entry and exit. Traders, who were short in the currency pair will look for exit and traders who were following the long term uptrend take a bullish position and enter the market.

Falling Three Methods

The Falling Three Methods is a major trend continuation pattern and is sometimes referred to as five candle patterns because of the confirmation candles at the first and fifth positions. These two long candles confirm the trend and its continuation. The sole of this pattern is the three counter-trend candlesticks in the middle. This pattern should never be considered as a reversal pattern; it is a clear trend continuation pattern.

Below is an image of how the pattern looks on the price chart

Criteria for the pattern

  1. The Falling Three Methods is a bearish continuation pattern with two long candlesticks in the direction of the main trend and three counter-trend candles in the middle of the two big bearish candles.
  2. The series of small-bodied candles should be of the same color. However, a bearish Doji as the third candle can also be considered.

This pattern is used by traders to initiate new short positions or add to an existing one. A trade is taken only after the fifth candle, which confirms that the trend is going to continue. There are also traders who use the 10-day moving average to confirm that the market is in a downtrend. While trading this pattern, one needs to make sure that this pattern is not at the key support level.

Conclusion

These are two famous triple candlestick trend continuation patterns. Make sure not to use these patterns stand-alone. They must be paired with other credible technical tools like indicators or chart patterns to confirm the authenticity of signals they generate. In the upcoming lesson, let’s look at some of the Reversal Triple Candlestick Patterns. Cheers!

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Forex Basic Strategies

Identify Reliable Trading Signals Using ‘Piercing Line’ Candlestick Pattern

Introduction

The Piercing Line is a simple and effective candlestick pattern, and it is used to trade the bullish reversals in the market. This pattern typically appears in a downtrend. Also, when it appears in a significant support area, we can consider it more reliable. Piercing Line is a two candlestick pattern where the sellers influence the first candle, and the second candle is responded by enthusiastic buyers. Piercing Line essentially indicates the bears losing control, and bulls taking over the market.

  1. First of all, in a downtrend, the first candle of the pattern should be bearish.
  2. The second candle should be bullish, and it should open lower than the closing of the previous candle, and it must close above the midpoint of the bearish candle.

This indicates that buyers now overwhelmed the sellers. In terms of supply-demand, this pattern shows that the supply is depleted somewhere, and the demand for buying has increased. Remember not to trade this pattern alone. Always use it in conjunction with some credible indicators or other trading tools to further enhance the probability of winning.

Piercing Line Pattern Trading Strategies

Piercing Line Pattern + Percentage Price Oscillator

In this strategy, we have paired the Piercing Line pattern with the Percentage Price Oscillator to generate credible trading signals. The Percentage Price Oscillator is a momentum indicator. It consists of a centerline, histogram, and the two moving averages. Just like the MACD indicator, the PPO also represents the convergence and divergence in price action. This indicator gives a crossover at the overbought and oversold market conditions.

When price action crosses the centerline, it means that the bullish or bearish momentum is super strong. We want to let you know that PPO is not that popular in the industry. Also, it is not available in the MT4 terminal. However, you can download this indicator from this link and add it to your MT4 terminal. If you are a Tradingview user, search the PPO indicator in the indicators tab, and you should be able to find it.

Step 1 – Find out the Piercing Line pattern in a downtrend.

Step 2 – Once you find the Piercing Line pattern, the next step is to wait for the reversal to happen on the PPO indicator at the oversold market conditions.

In the below CHFJPY chart, the market was in an overall downtrend. We can see the market printing Piercing Line pattern, and that is an indication of a trend reversal. We can also see the PPO indicator giving crossover in the overbought area at the same time. Both of these clues indicate a clear buy signal in this pair. We can also see the price action showing divergence, which is another clue to go long. If we are able to find all of these clues on a single price chart, we shouldn’t mind placing bigger trades.

Step 3 – Stop-loss and Take Profit

PPO indicator quite often gives high probability trading signals. So when we take trades of that kind, most of the time, we must place the stop loss just below the first candle of the Piercing Line indicator.

There are several ways to book profits. For this particular strategy, we can close our position when the PPO reversed at the overbought area or when the market starts printing the opposite pattern. If you plan to make more money in a single trade with extra risk, it is advisable to book the profit at the higher timeframe’s major resistance area.

In the below chart, we can see that we have closed our whole position at the major resistance area and the stop-loss order was just below the recent low.

Piercing Line Pattern + Double Moving Average

In this strategy, we have paired the Piercing Line pattern with the Double Moving Average. Moving Average is a very well-known indicator in the industry. Many average indicators are available in the market. If you are using the lower period average, expect more trading signals. Contrarily, if you are using the higher period average, expect fewer but accurate signals.

Step 1 – First of all, find out the Piercing Line pattern in a downtrend.

Step 2 – Activate the buy trade when the lower period MA crosses the higher period MA. In the below EURAUD Forex chart, the price action was in a downtrend, and around the 22nd of December, the market prints the Piercing Line pattern. This means that the sellers now have a hard time to go lower, and buyers took over the market. Furthermore, when a lower period moving average crosses the higher period moving average, it is a clear indication to go long. After our entry, price action immediately prints a brand new higher high.

Step3 – Stop-loss and Take Profit

If you are an aggressive trader, use the recent low for stop loss. But if you are a conservative trader, make sure to place wider stop losses. If you plan to ride the longer moves, wait for the price action to hit the daily support area. But if you plan to go for intraday trades only, we suggest you exit your position when the double MA gives the opposite signal.

In the below chart, we can see that we have closed our full positions at the higher timeframe major resistance area, and stop-loss was just below the recent low. Overall, it was a 3R trade.

Bottom Line

Piercing Line pattern is a bottom reversal pattern, and it is one of the very well-known bullish reversal patterns. We can say that this pattern is exactly the opposite of the Dark Cloud Cover pattern. We won’t be able to see this pattern very frequently on the price chart, but when it appears, a trend reversal is guaranteed. Sometimes you will find this pattern in the consolidation phase, but it’s not worth your time to trade it in ranges. So it is always recommended to find this pattern in a clear trending market because that’s where we can generate more effective signals. The only limitation of this pattern is that it requires the use of other technical tools to confirm the signal and cannot be used stand-alone. But that’s the case of most of the candlestick patterns, so that’s not a major limitation.

That’s about the Piercing Line candlestick pattern. Let us know if you have any questions in the comments below. Cheers!

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Forex Basic Strategies

Trading The ‘Three White Soldiers’ Candlestick Pattern (With RSI & EMA)

Introduction

The Three White Soldiers is a bullish candlestick pattern. This pattern is highly reliable and quite potent when it is found at a significant support area in a downtrend, which indicates sharp price reversals from a bear market to a bull market.

  1. Three White Soldiers pattern consists of three consecutive bullish candles; typically, this pattern should be traded when found at the end of a downtrend.
  2. Each candle should open and close higher than the previous candle.
  3. The candles must have small or no wicks. Because that indicates, the buyers managed to close the price of the currency pair at the high of a candle. If the third candle is smaller than the preceding two candles, it indicates that the buyers do not have much strength, and the market can easily print a new lower low.

Candles get printed on every trading chart in all the timeframe. But only the candlestick patterns in the right context of the market will be rewarded. The Three White Soldiers pattern that we are going to discuss is one of the most credible and reliable patterns we have come across. Trading legend Gregory L. Morris, in his book ‘Candlestick Charting Explained,’ said that the Three White Soldiers is extremely rewarding if traded correctly and it should never be ignored.

Trading Strategies

Three White Soldiers + RSI indicator

In this strategy, we have paired the Three White Soldiers pattern with the RSI indicator to identify good trading signals. RSI is a well-known oscillator, and it stands for the Relative Strength Index. The RSI indicator has a reading from 0 to 100. When the indicator line goes above the 70, it indicates the overbought conditions. When the indicator lines go below the 30 levels, it means the market is in an oversold condition.

Step 1 – First of all, find the Three White Soldiers pattern in a downtrend.

Step 2 – When market prints the Three White Soldiers, our next step is to check the RSI indicator. If the RSI indicator is at the oversold area and gives a sharp reversal, it means that both of the trading tools support the buying entry in any underlying currency pair.

In the example below, GBPNZD was in an overall downtrend. At first, market prints the Three White Soldiers pattern, and the RSI was at the oversold area. This condition indicates a potential trend reversal. We can see that the pattern candles are quite strong, and the RSI indicator also supported our strategy. This aspect creates an illusion for novice traders to take the trade immediately. However, it is not a good way to enter the trade. We suggest you always wait for 2-3 candles to confirm the stability of the pattern.

Step 3 – Step Loss & Take Profit

In this example, we have put the stop loss just below the low of the first candle of three green candles. When two leading trading tools indicate the same signal, always use smaller stops so that you can maximize your profits.

For this strategy, there are several ways to book the profit. We can close our position at a significant resistance area or when the RSI indicator reaches the overbought area. If your plan is to ride the longer moves, we suggest you closing your position when the market prints the Three Black Crows patterns. This pattern is the complete opposite of the Three White Soldiers pattern.

The example below belongs to the daily chart. Keep in mind that stronger the support/resistance area on the higher timeframe, more chances the market has to respect that area. In our example, the last time price respects the resistance line, so we decided to close our full position at a resistance area. Overall it was 1500+ pip move on the daily chart. These kinds of higher timeframe trades are suitable only for big investors.

Three White Soldiers + EMA

In this strategy, we have paired the Three White Soldiers pattern with the EMA to filter out the bad trading signals. EMA stands for Exponential Moving Average. The EMA is used to highlight the current trend and to spot the trend reversals. Trading signals can also be generated when the EMAs are read correctly. Generally, when the EMA goes above the price action, it indicates a sell signal, and when it goes below the price action, it indicates a buying signal.

Step 1 – Of course, the first step here is to identify the Three White Soldiers pattern on the charts.

Step 2 – When market prints, the Three White Soldiers, and EMA go below the price action, it indicates the buying signal.

In the below EURAUD weekly Forex chart, when the market prints the Three White Soldiers pattern, EMA was also below the price action. This indicates a potential price reversal of this currency pair. Even when both the pattern and EMA indicates the signal, we decided to wait for 3 to 4 candles to confirm the strength of the pattern. We can see that the market holds there for a couple of candles, which is a clear cut sign to go long on this pair.

Initially, the market goes higher for some candles, but it didn’t reach our major target. Our position goes into the loss a couple of times. Do not panic and lose trust in your strategy because the price didn’t hit the stop loss yet. Trading is a game of patience and only close your position when the market hit the stop loss or take profit. In this case, waiting patiently led to fruitful results as our trade hits the take profit.

Step 3 – Stop Loss & Take Profit

In the above chart, we have placed the stop loss above the exponential moving average because it works as a dynamic support/resistance to price action. We closed our full position when EMA goes above the price action.

Conclusion

Most of the times, Three White Soldiers pattern appears at the end of a downtrend. Sometimes it also prints after a lengthy consolidation phase. Although it is not a strong bullish sign if you want to trade the consolidation phase, always pair this pattern with other technical tools to filter out the negative signals. The volume is the most critical thing to enhance the reliability of the pattern when the market is in a consolidation phase.

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Forex Assets

What Should You Know About EUR/GBP Forex Pair Before Trading

Introduction

EURGBP is the abbreviation for the currency pair Euro area’s euro against the Great Britain pound. This pair, unlike the EURUSD, USDCAD, GBPUSD, USDCHF, etc. is not a major currency pair. This pair is classified under the minor currency pairs and the cross-currency pairs. In EURGBP, EUR is the base currency, and GBP is the quote currency.

Understanding EUR/GBP

The current market price of EURGBP depicts the required number of pounds to purchase one euro. For example, if the value of EURGBP is 0.8527, then one needs to pay 0.8527 pounds to buy one euro.

EUR/GBP Specification

Spread

Spread in trading is the difference between the bid price and the ask price. The spread is not the same on all brokers but depends on the type of account. It also varies depending on the volatility of the market. An average spread on an ECN account and an STP account is shown below.

Spread on ECN: 0.8 | Spread on STP: 1.5

Fees

On trade a trader takes, there is some fee associated with it. Fees, again, depends on the type of account. There is no fee on STP accounts, but few pips on ECN accounts.

Slippage

When a trader executes a using the market order, they don’t really get the price they had intended. There is a small pip difference between the two prices. And this difference between the prices is referred to as slippage. The slippage is usually within 0.5 to 5 pips.

Trading Range in EUR/GBP

Understanding the volatility of the market is essential before opening or closing a position. It shows how much profit or loss a trader will be on a particular timeframe. For example, if the volatility is on the 4H is 10 pips, the trader can expect to gain or lose $1269 (10 pips x 12.69 value per pip) in a matter of about 4 hours.

The table below illustrates the minimum, average, and maximum pip movement on the 1H, 2H, 4H, 1D, 1W, and 1M timeframe.

EUR/GBP PIP RANGES

Procedure to assess Pip Ranges

  1. Add the ATR indicator to your chart
  2. Set the period to 1
  3. Add a 200-period SMA to this indicator
  4. Shrink the chart so you can assess a large time period
  5. Select your desired timeframe
  6. Measure the floor level and set this value as the min
  7. Measure the level of the 200-period SMA and set this as the average
  8. Measure the peak levels and set this as Max.

EUR/GBP Cost as a Percent of the Trading Range

An application of the volatility would be the determining of cost on each trade. As in, the ratio between the volatility and the total cost on each trade is calculated and is expressed in terms of percentage. The percentage depicts the cost for a particular timeframe and volatility. The comprehension of it shall be discussed in the subsequent section.

ECN Model Account

Spread = 0.8 | Slippage = 2 | Trading fee = 1

Total cost = Slippage + Spread + Trading Fee = 2 + 0.8 + 1 = 3.8

STP Model Account

Spread = 1.5 | Slippage = 2 | Trading fee = 0

Total cost = Slippage + Spread + Trading Fee = 2 + 1.5 + 0 = 3.5

The ideal way to trade the EUR/GBP

With the above two tables, let us figure out the ideal way to trade this currency pair. Note that the higher the percentage, the higher is the cost on a trade and vice versa. It is evident from the chart that the percentages are highest for the minimum column and lowest for the max column. In other words, the cost is high when the volatility of the market is low, and the cost is low when the volatility is high. So does this mean it is ideal to trade when the volatility is high? Well, that’s not the right approach to it, as trading in high volatility is risky. So, it is ideal to take trades during those times when the volatility is around the average range. Doing that will ensure marginal cost as well as decent cost. For example, a 4H trader must take trades during those occasions when the volatility is around 20 pips.

Note: One can apply the ATR indicator to determine the current volatility of the market.

Another feasible way to reduce costs is by canceling out the slippage cost. Cancel slippage costs can simply be done by placing limit orders. With limit orders, the slippage automatically becomes 0.

The difference in the cost percentage when the slippage goes to zero is illustrated as follows.

We hope you find this Asset Analytics informative. Let us know if you have any questions in the comments below. Cheers!

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Forex Course

40. Two Different Types Of Spreads In The Forex Market

In the last lesson, we clearly talked about what Spread in forex is and also how it is calculated. In this lesson, we will dig up a little more on the concept of spreads and understand its types.

In Forex, the spread is of two types:

  • Fixed spread
  • Variable/Floating spread

Fixed spreads are typically offered by Dealing Desk brokers, whereas, Variable spreads are offered by No Dealing Desk brokers. Let’s understand both in detail.

Fixed Spreads in Forex

As the name pretty much suggests, Fixed spreads remain the same regardless of the condition of the market. Be it a volatile or non-volatile market, the spread always stays the same.

As mentioned, these spreads are usually offered by Market Makers type of brokers.

Dealing Desk brokers buy a large number of positions from their liquidity providers and then offer these positions to traders (clients). Since the brokers will own these positions, they can control and display the prices to their clients with a fixed spread.

Why choose Fixed Spreads?

  • Fixed spreads do not require a large capital to trade. So, fixed spread brokers offer an alternative for traders who don’t have much cash to begin with.
  • “Fixed” spread itself is an advantage. Fixed spreads make it easy to calculate the transaction costs. And since spreads always remain constant, you will exactly know how much amount you will be paying to the broker for each trade.

Variable Spreads in Forex

Again, as the name suggests, Variable spreads are the spreads that are constantly changing, just like the exchange rates. That is, as and when the bid and ask price changes, the difference between the two changes. This, therefore, changes the spread as well.

This type of spread is offered by Non-Dealing Desk brokers. These brokers obtain the prices from multiple liquidity providers and directly pass on these prices to the traders without the involvement of a dealing desk. This means that NDD brokers do not have control over the spreads. It all depends on the market’s supply and demand and its overall volatility.

As a typical tendency of the market, when there is an economic event, the spreads widen. And same is the case when the market volatility drops.

Advantages of Variable spreads

  • Variable spreads diminish the experience of requotes, where requote is the difference in the price you hit the buy/sell and the price when your order reached the broker. However, this doesn’t mean that you won’t experience slippage.
  • Variable spreads provide transparent pricing, as you will be getting the prices from multiple liquidity providers, which in turn means better prices due to high competition.

If you’re wondering which type of spread you must choose? Well, it completely depends on the type of trader you are. For example, traders with small accounts who trade occasionally can go with a broker that offers fixed spread, whereas, a trader who wants fast execution and also wants to avoid requotes, can look for brokers offering variable spreads.

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Forex Assets

What Should You Know About AUD/USD Forex Pair

Firstly, the abbreviation of the AUDUSD currency pair is the Australian dollar and the US dollar. AUDUSD is a major currency pair. It is considered a major pair because it is AUD is paired with the US dollar, and also, this is one of the pairs where a huge volume of trading takes place. In AUDUSD, AUD is the base currency, and USD is the quote currency.

Understanding AUD/USD

The exchange value of AUDUSD represents the units of USD equivalent to one unit of AUD. In technical terms, it is the value of AUD against USD. For example, if the current market price of AUDUSD is 0.6960, then it means that it takes 0.6960 US dollars to buy 1 Australian dollar. Trading the AUDUSD currency pair is basically trading the Aussie (Australian dollar).

AUD/USD Specification

Spread

Spread is the difference between the bid price and the ask price. The spread usually varies based on account type. The spread on an ECN account and an STP account is as follows:

ECN: 0.7 | STP: 1.4

Fee

There is charged by brokers for every trade a trader takes. However, this depends on the type of forex account. Typically there is a fee in ECN accounts and zero-fee in STP accounts. Also, there is no exact value of fee on a single trade, as it differs from broker to broker.

Slippage

Slippage is the difference between the trader’s requested price and the real executed price. Slippage happens when the volatility of the market is quite high. It happens for market orders. Slippage can be in favor of the trader or against him. If entering and closing of the trade is done by market execution, then slippage happens twice. The slippage is usually between 0.5 and 3 pips. However, it depends on the broker’s execution speed as well.

Trading Range in AUD/USD

There are several timeframes to trade this currency pair. A day trader may pick the 1H, 4H, or the 1D timeframe, while a positional trader may opt for the weekly or the monthly. Apart from analyzing these timeframes, it is also necessary to know the volatility range in each of the timeframes. Knowing the pip movement range in each timeframe, one can assess their risk involved in each trade.

Below is the table, which represents the minimum, average, and maximum pip movement in each timeframe.

Note: The below values are an approximation from the Average True Range (ATR) indicator.

AUD/USD PIP RANGES 

Procedure to assess Pip Ranges

  1. Add the ATR indicator to your chart
  2. Set the period to 1
  3. Add a 200-period SMA to this indicator
  4. Shrink the chart so you can assess a large time period
  5. Select your desired timeframe
  6. Measure the floor level and set this value as the min
  7. Measure the level of the 200-period SMA and set this as the average
  8. Measure the peak levels and set this as Max.
GBP/USD Cost as a Percent of the Trading Range

This is where the above values are put into play. By considering the volatility range in each timeframe, the cost (fee) for a single trade is measured in terms of a percentage for every mentioned timeframe. The basic idea to this is that the higher the percentage value, the higher is the cost of the trade.

The cost is calculated by considering three variables, namely, slippage, spread, and trading fee. And the sum of these values gives the total cost of each trade.

As mentioned earlier, the cost varies from the type of trading account. So, there will be variation in cost percentages as well.

ECN Model Account

Spread = 0.7 | Slippage = 2 | Trading fee = 1

Total fee = Spread + Slippage + Trading fee = 0.7 + 2 + 1

Total cost = 3.7 (pips)

STP Model Account

Spread = 1.4 | Slippage = 2 | Trading fee = 0

Total cost = Slippage + Spread + Trading Fee = 2 + 1.4 + 0

Total cost = 3.4

The Ideal Timeframe to Trade GBP/USD

The first observation that can be made from the above percentage values is that the minimum column has the highest percentages compared to other columns. This means that the cost is pretty high when the volatility of the market is too low irrespective of the timeframe. Contrarily, the costs are significantly less when the volatility of the market is high (max column). However, it is quite risky to trade when the market volatility is high though the fee is less. So, it is ideal during those times of the day when the market volatility is above average.

Note that volatility is not only one which decides on which is the best timeframe and time of the day to trade. The slippage value equally plays an important role, as well. For instance, if the slippage is made nil and the percentages are calculated, it is seen that the ranges drop down considerably. Hence, it is recommended to enter and exit trades using limit orders and not market orders.

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Forex Assets

Everything You Should Know To Trade The GBP/USD Forex Pair

Introduction

Currency pairs are classified as major, minor, exotic, etc. Major currencies pairs are those pairs that involve the US dollar as one of the currencies. These currencies typically have high liquidity and volatility. GBPUSD is one such example. It is the currency pair where Great Britain Pound is traded against the US dollar.

In this article, we shall be covering all the basic fundamentals which are essential to know before trading this pair. And before getting into the specifications of this pair, let us first understand what actually the price of GBPUSD signifies.

In GBPUSD, GBP is the base currency, and USD is the quote currency. The value (price) of the pair determines the units of USD required to purchase one unit of GBP. For example, if the current value of GBPUSD is 1.3100, then the trader must possess the US $1.3100 to buy 1 Pound.

GBP/USD Specification

Spread

Spread is simply the difference between the bid price and the ask price. The spread depends on the type of account.

Spread on ECN: 0.7

Spread on STP: 1.3

Fees

Again, the fee depends on the type of account. Typically, there is no fee charged by STP accounts. There is a trading fee on ECN account, which depends from broker to broker.

Slippage

Forex is very liquid and volatile. Hence, this causes slippage. Slippage is the difference between the price requested by the trader and the actual price the trader received. And this depends on the broker’s execution speed and volatility of the market. The slippage in major currency pairs is usually within 0.5 and 5 pips.

Trading Range in GBPUSD

As a trader, it is vital to know the number of pips a currency pair moves in a period of time. This is basically the volatility in the currency pair. And volatility is one of the factors which are helpful in risk management.

The volatility is measured in terms of percentage or pips. For example, if the volatility on the 1H timeframe of GBPUSD is 15 pips, then one can expect to gain or lose $150 (15 pip x $10 per pip) within a time period of few fours.

Below is a table that depicts the minimum, average, and maximum volatility (pip movement) on different timeframes.

EUR/USD PIP RANGES

Procedure to assess Pip Ranges

  1. Add the ATR indicator to your chart
  2. Set the period to 1
  3. Add a 200-period SMA to this indicator
  4. Shrink the chart so you can assess a large time period
  5. Select your desired timeframe
  6. Measure the floor level and set this value as the min
  7. Measure the level of the 200-period SMA and set this as the average
  8. Measure the peak levels and set this as Max.

(originally posted in our article here)

GBPUSD Cost as a Percent of the Trading Range

A Forex broker usually levies three type of charges for each trade. They are:

  • Slippage
  • Spread
  • Trading Fee

The sum of all the three costs will generate the total trading cost for one trade.

Total cost = Slippage + Spread + Trading Fee

Note: All costs are in terms of pips.

To bring up an application to the above volatility table, we bind these values with the total cost and find the cost variations (in terms of percentages) on different timeframes. And these percentages prove to be helpful in choosing the right timeframe with minimal costs.

ECN Model Account

Spread = 0.7 | Slippage = 2 | Trading fee = 1

Total cost = Slippage + Spread + Trading Fee = 2 + 0.7 + 1

Total cost = 3.7

STP Model Account

Spread = 1.3 | Slippage = 2 | Trading fee = 0

Total cost = Slippage + Spread + Trading Fee = 2 + 1.3 + 0

Total cost = 3.3

The Ideal Timeframe to Trade GBPUSD

Above are tables that illustrate the cost ranges in terms of percentage. Let us now comprehend the tables and figure out the ideal timeframe to trade this currency pair. From the above table, it is evident that the cost is highest (74% and 66%) in the 1H timeframe when the volatility is low. Hence, it is not ideal to pick the 1H timeframe when the volatility is around 5 pips (minimum).

On the flip side of things, the cost percentages are minimal on the 1M timeframe. Traders with a long term perspective on the market can invest with minimum costs.

Intraday traders, on the other hand, can pick the 1H, 2H, 4H, or the 1D timeframe when the volatility of the market is above average.

Another point to consider is that slippage eats up the costs significantly. So, it is recommended to plan strategies that involve placing of limit orders and not market orders.

As proof, below is a table that clearly shows the reduction in the cost percentages when the slippage is made NIL.

Total cost = Slippage + Spread + Trading fee = 0 + 0.7 + 1

Total cost = 1.7

Comparing these values to the table with slippage=2, it can be ascertained that the cost percentage has reduced by a considerable amount. Hence, all in all, it is ideal to trade by placing limit orders rather than executing at the market price.

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Forex Basic Strategies Forex Trading Strategies

How To Trade The Engulfing Candlestick Pattern Using Support/Resistance

Introduction

Engulfing is one of those candlestick patterns in the forex market that provides a useful way for traders to anticipate a possible reversal in the trend. There are two types of engulfing patterns – Bullish Engulfing and Bearish Engulfing. The engulfing candle’s bearish or bullishness is wholly based on its position in relation to the existing trend of an underlying asset.

Understanding The Types

A bullish engulfing pattern can appear anywhere in the trend. But it holds more significance if it appears in a downtrend. This pattern indicates the surge in buying pressure as it shows that more buyers are entering the market, driving the price action further up. This pattern consists of a bearish red candle and the second bullish candle completely engulfs the body of the previous red candle.

Interpretation – Always look for the bullish engulfing pattern in a clear downtrend. For entering a trade, traders must combine this pattern with support resistance levels or with any reliable technical indicator for additional confirmation of the trend reversal.

Bearish engulfing pattern is just the opposite of the bullish engulfing pattern. Instead of appearing at the bottom of the trend, this pattern appears at the top of the trend. We can say that more accurate and reliable signals can be generated when this pattern appears at the top of an uptrend. The bearish engulfing pattern consists of two candles. The first one being the green candle. This one is, next, engulfed by the subsequent red candle. The pattern triggers a reversal in an existing trend. It indicates the buyers are no longer able to push the price higher, and the bears took control of the market.

Interpretation – Always look for the bearish engulfing pattern in a clear uptrend. The second red candle must engulf the green candle ultimately, showing that bears are piling into the market aggressively. For entering a trade, traders must look for additional confirmation, such as support resistance levels or by using any reliable technical indicator.

Pairing the Engulfing pattern with Support/Resistance

Every trader has a unique way of trading the market. Some traders like to go with the trend while some traders only trade counter-trend moves. In this strategy, we have paired the engulfing pattern with support & resistance to show you how to trade the reversals correctly.

Confirm the downtrend first on your trading timeframe 

The first step of this trading strategy is to confirm the trend of any underlying asset. Let’s trade the bullish engulfing pattern. So as discussed, we should be finding the downtrend on the price chart. As you can see in the below NZD/USD currency pair was in an overall downtrend.

Find out the Bullish Engulfing pattern on your trading timeframe

The key to successful trading is to follow all the rules of the trading strategy. The engulfing pattern can be seen all over the price chart, but obviously, we can’t trade all of these patterns. We should be trading only those engulfing patterns that appear in the major support area.

In the below image, the NZD/USD was in an overall downtrend, and price action respects the major support area. Market prints the engulfing pattern at the support zone, which indicates that the buyers are more likely to lead the price.

Entry, Take Profit & Stop loss

Enter the trade right after you see the bullish engulfing pattern at the S&R area. Take-profit targets depend on your trading style. If you are a swing trader or full-time trader, hold your positions for more extended targets. If you are an intraday trader, close your position at the nearest resistance area.

You can also book partial profits at a significant resistance area and close your full position when the market prints the bearish engulfing pattern. In this strategy, we took the buy at a significant support zone, so it’s a healthy practice to put stop loss just below the support area.

Look at the below image; you can see that price action goes above the significant resistance area. But we made sure to close our positions at the resistance area as we don’t want our money to be blocked in a single trade for a long time. Overall it was good 4R trade.

Bottom Line

There are so many different ways to take trades to use the engulfing pattern. Statistically, the engulfing pattern works better when traded at the bottom or top of the trend. So make sure to check their location before placing the trades. One other possible way to trade am Engulfing Pattern is when it is combined with Moving Averages. But even that way, make sure to trade the engulfing pattern at the significant support and resistance areas. Some traders use reliable indicators like MACD to confirm the trend reversals by using the overbought and oversold levels. That’s about the Engulfing pattern strategy. Make sure to find these patterns and trade them in your upcoming trading activities. Let us know if you have any questions in the comments below. Cheers!

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Forex Basic Strategies Forex Trading Strategies

Trading The Morning Star Candlestick Pattern Like A Pro!

Introduction

Morning star is a bottom reversal pattern, and it primarily consists of three candlesticks that indicate the bullish sign. This pattern warns the weakness in an ongoing downtrend that, in turn, suggests the start of an uptrend. Traders observe the formation of a Morning Star pattern on the price chart, and then they can confirm it with other technical tools.

The Three Candlesticks Of Morning Star Pattern

  • Large Bearish Candle
  • Small Bullish or Bearish Candle
  • Large Bullish Candle

The most fundamental thing to remember is that the market should be in a downtrend to trade the Morning Star pattern. To confirm the downtrend, mark the lower lows and lower highs.

Large Bearish Candle is the first part of the Morning star reversal pattern. The bearish candle indicates the bears are in complete control, which means the continuation of the selling pressure. At this point in the market, we should only be looking for the sell trades as there is no sign of reversal yet.

Small Bullish/Bearish Candle is the second candle that begins with a bearish gap down. This candle indicates that the sellers fail to push the price lower, despite trying really hard. The price action ends up forming a quite small bullish/bearish or Doji candle. If this candle is a small bullish candle, it’s an early sign of trend reversal.

Large Bullish Candle is the third candle that holds the most significance because the real buying pressure is revealed in this candle. If this candle begins with a buying gap, and if buyers can push the prices higher by closing the candle even above the first red candle, it is a definite indication of a trend reversal.

Trading strategy – Morning Star Candlestick Pattern

As we know by now, the Morning star is a reversal pattern. It mainly indicates the bulls taking over the trend while the bears lose the grip. Most of the beginners tend to trade the Morning Star pattern stand-alone. But we do not recommend this as it is not reliable enough. Always pair this pattern with some other credible indicators, support resistance levels, or trend lines to make profitable trades.

Morning Star Pattern + Volume

In this strategy, we have paired the Morning Star pattern with the volume. The volume plays a significant role in pattern formations. If the first red candle shows a low volume, it is a good sign for us. Then, if the second candle is green and the volume rises, it indicates the buying pressure. Lastly, the long green candle’s volume must be high. The high volume on the last candle shows the confirmation of the upcoming buy trend. If the third bullish candle has low volume, then try avoiding that Morning Star Pattern because the volume is not indicating the bullish reversal. If you observe the third candle closing with high volume, take up the buying position and ride the uptrend until there are any indications of a trend reversal.

Confirm the downtrend on the trading timeframe

Confirmation is very important because, if there is no downtrend, there’s no point in trading the Morning Star pattern. You can confirm the downtrend on a higher timeframe or on your trading timeframe. As you can see in the below image, the overall trend of the CAD/CHF Forex pair was down.

Find out the Morning star pattern on your trading timeframe

As you can see in the below CAD/CHF chart, the market prints the Morning Star pattern by following all the rules of our strategy. The first red candle was with low volume, and the second one was a small red candle. Hence there is no indication to go long in this pair yet. The very next was a long green candle with high volume. This is a strong indication of a trend reversal.

Entry, Take Profit and Stop Loss

We should be entering the trade when the next green candle closes. There are so many different ways to book profit. We can close the position at any resistance area or supply-demand zone. In this trade, we hold our positions because we took the trade from the beginning of a new trend. You can also close your positions when the price goes near the higher timeframe’s significant resistance level.

Pairing this pattern with volume makes it more reliable to trade. So it is a good idea to place the stop loss just below the second candle. In the above picture, you can see that we have put the stop loss just below the second candle, and we have also booked the profit at the higher timeframe’s major resistance area.

Reliability of Morning Star Pattern

This pattern is very easy to identify on the price chart if you are an intermediate trader. Even novice traders can easily spot it on the chart with little practice. Morning Star pattern often gives us well-defined entries and good risk-reward ratios. The only limitation of this pattern is that, if the sellers are strong enough, the prices could go further down despite the formation of the Morning Star Pattern. Hence it is always recommended to combine this pattern with some other trading tools rather than trading it stand-alone.

We hope you find this article informative. Try trading this pattern when you see a perfect downtrend next time. Let us know how the results have been in the comments below. Cheers!

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Candlestick patterns Forex Basic Strategies Forex Trading Strategies

Pairing The Hanging Man Candlestick Pattern With MACD Indicator

Introduction

The Hanging Man is a visual candlestick pattern which is used by traders and chartists in all type of markets. The term ‘Hanging Man’ refers to the shape of the candlestick. Visually the hanging man looks like a ‘T,’ and it appears in an uptrend. The formation of this candlestick is an indication that the uptrend is losing its strength. Meaning, sellers started showing interest, and the current trend of an asset is going to get reversed. Anyone can easily predict from the name of this pattern that it is viewed as a bearish sign.

The Hanging Man candle composes of a small body and a long lower shadow with little or no upper shadow. The vital point to remember is that the hanging man pattern is a warning of the upcoming price change, so do not take it as a signal to go short. Also, trading solely based on one pattern is risky. To confirm the sign given by the Hanging Man pattern, traders must pair it with support resistance or any other trading indicator.

This pattern is not confirmed unless the price falls shortly after the Hanging Man. If the next candle closes above the high of the Hanging Man, this pattern is not valid. After the pattern, if the very next candlestick falls, then it’s a clear indication of the reversal. Now, if you see a Hanging Man candlestick and the above-discussed rules apply, you can go ahead and take the trade. But since it is crucial to have an extra confirmation, let’s pair this pattern with a technical indicator.

Pairing the Hanging Man Pattern With MACD Indicator

In this strategy, we have paired the Hanging Man pattern with the MACD indicator so that we can filter out the low probability trades. MACD stands for Moving Average Convergence and Divergence, and it is one of the most popular indicators in the market. It is essentially an oscillator that is used for trading ranges, trend pullbacks, etc. Also, this indicator identifies the overbought and oversold market conditions. In this strategy, we are using the default setting of the MACD indicator to identify the trades.

Step 1 – Confirm the uptrend first on your trading timeframe

We can’t use the Hanging Man pattern to take the buy trades. Since it is a reversal pattern, it only signals the selling trades. So first of all, find out the uptrend in any currency pair. One more primary thing to remember when trading this pattern is this – After finding a clear uptrend, if you see the market printing the Hanging Man, then try not to trade that pair. Because, in a strong trend, it’s not easy for a single candle to change the direction of the entire trend. But if you find this pattern when the uptrend is a bit choppy, it has higher chances to perform. As we can see in the image below, the uptrend in USD/CHF was not strong enough.

Step 2 - Find out the Hanging Man pattern on your trading timeframe

Some traders use two or three timeframes to trade patterns. But that’s not the right way of pattern trading. If you are an intraday trader, use only lower timeframes to identify the pattern. So the next step here is to find out the Hanging Man in this chart. Also, apply the MACD indicator. For us to go short, the MACD indicator must be in the overbought area.

As you can see in the image below, the USD/CHF Forex pair prints a Hanging Man pattern. This is the first clue for us that the buyers aren’t able to push the market higher. Soon after the crossover happened on the MACD indicator, we can say that this forex pair is in the overbought condition. So now, two forces are aligned, and they are indicating us to go short. Within a few hours, the pair rolls over, and it prints brand new lower low.

Step 3 – Entry, Take Profit & Stop Loss

We go short as soon as we see the Hanging Man candlesticks and MACD indicator at the overbought area, we can go short. In this pair, buyers were quite weak, and this is an indication for us to place deeper targets. As we suggest in every strategy, often close your position at significant support/resistance area, or when the market starts to print the opposite pattern. In this pair, we closed our full trade at 0.9844. Overall it was 7R trade, and we made nearly 140+ pips.

Placing the stop loss depends on what kind of trader you are. Some advanced traders use their intuition to close their positions, while some use logical ways such as checking the power of the opposite party. In this trade, we know that the buyers are not strong enough, so there is no need to use the spacious stop loss.

Difference Between Hanging Man and Hammer Patterns

The Hanging Man and Hammer both look the same terms of size and shape. Both of these patterns have long, lower shadows and small bodies. But the Hanging Man forms in an uptrend, and it is a bearish reversal pattern. Whereas the Hammer forms in a downtrend, and it is a bullish reversal pattern. These two patterns appear in both short and long term trends. Do not use these patterns alone to trade the market. Always use them in conjunction with some other reliable indicators or any other trading tool.

Bottom Line

Most of the professional traders never see this pattern alone as a predictor of a potential trend reversal. Because there will be times when the price action continues to move upward even after the appearance of the Hanging Man. Hence technical indicator support is required to confirm the reversal of the trend. Make sure to stick to the rules of the pattern so that you can use it to your advantage. This pattern forms in all the timeframes, but we suggest you master it on a single timeframe first. Cheers!

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Forex Course

33. Understanding Leverage & Its Relationship With Margin

Leverage

There is a close relationship between the Leverage and Margin. That is, both go hand in hand. In simple terms, the margin is used to create leverage. The meaning of leverage is similar to the margin. It is a facility provided by brokers, which allows a trader to take larger positions by investing a lesser amount than required.

Margin is expressed in percentage, while Leverage is expressed as a ratio

Leverage is the ratio between the capital a trader has in their account to the amount of capital he/she can trade. And this ratio is expressed in the form “X:1,” where X is the amount of leverage.

Expressing Margin in terms of Leverage

If a trader wishes to purchase one mini lot of a currency, they don’t need $1,000 in their account balance. Instead, they will need only a small percentage of the position size. And this percentage is referred to as Margin Requirement.

This same percentage in terms of a ratio is termed as Leverage.

For example, let’s say John wants to buy 100,000 units of USD/CAD. If the Margin Requirement is 1%, John will require only $1,000 to take this trade. That is, the Leverage for this trade would be 100:1.

Calculating the Leverage

Leverage is calculated using the below formula

Leverage = 1 / Margin Requirement

Considering the above the example,

Leverage = 1 / 0.01

Leverage = 100

Hence, the leverage will be 100:1.

Similarly, if the Margin Requirement is 2%, the Leverage will be 50:1.

Conversely, using Leverage, we can obtain the Margin Requirement as well.

Margin Requirement = 1 / Leverage 

For example, if the Leverage is 500:1, the Margin Requirement  = 1 / 500 = 0.002

Hence, the Margin Requirement when Leverage is 500:1 will be 0.002 or 0.2%.

Mostly, Margin and Leverage have an inverse relationship.

Forex Margin and Stock Margin

Forex margin and Stock (Securities) margin are two completely different terms, though both are from the same trading industry.

In the Stock market, the margin is the amount a trader borrows from their broker to purchase a stock. Basically, it is like borrowing funds as a loan from their broker.

Whereas in the Forex market, the meaning of margin is different. Here, as we know, it is the amount of money a trader will have to keep aside with the broker as a deposit to open a margin position.

Hence, to sum it up, we can consider margin either as a loan provided by the brokers or as collateral collected by the respective brokerage firm.

[wp_quiz id=”52027″]
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Forex Basic Strategies Forex Trading Strategies

Trading False Breakouts Like a Professional Forex Trader

Introduction

Often there are times in the market when the price breaks a certain significant level, and most of the novice traders immediately jump into the market. But, suddenly, the price reverts quickly, stopping out these traders or putting them in a losing position. Most of the experienced traders would have exited their positions when they realized they are trapped by the big whales like industry or institutional traders.

But beginner traders often become the victims of these false breakouts, and it affects their psychology as well. They will start doubting their trading strategies, and the fear element will surpass their confidence. Instead of falling into the negative state of mind, traders should learn how to use these false breakouts to their advantage so that they can profit from it. In this article, let’s discuss how to trade the false breakouts properly.

Most of the traders often consider false breakouts as a negative thing in the market. The general perception is that, by trading the false breakouts, they are taking the unnecessary risk, or it is not the correct way to trade. Some traders also believe that simple breakouts are more comfortable to trade. It is true, but simple breakouts won’t provide a great risk-reward, and also, it is not a consistent way to trade the market. On the other hand, successful & experienced traders see the false breakout logically and consider it as an opportunity to make some quick profits.

There are a lot of ways to trade false breakouts. Some traders trade them in conjunction with indicators, and some use it with trend lines and support resistance. In this strategy, we will show you the most appropriate way of trading false breakouts.

Trading the false breakout by using the major S&R levels

False breakouts occur in all types of markets, such as Forex, Stocks, Futures, and Options. They also occur in all kinds of market conditions. But the critical thing to remember is that every false break out is not worthy enough to trade. Always consider trading the false breakouts by following the trend of the market. That is, if the trend is up, look for the buy-side false breakout and in a downtrend, look for sell-side false breakouts.

Step 1 – Find the trend of the higher timeframe

This step is simple yet crucial because we need to confirm the trend of the market. Keep in mind that most of the lower timeframes always follow the direction of the higher timeframe. To explain this strategy, we are examining the uptrend of the GBP/USD forex pair.

Step 2 – Look for the significant S&R in the lower timeframe

Most of the false breakouts occur near the support and resistance level. The reason brokers and market movers use these levels is to manipulate the market as is these areas act as a significant supply-demand zone. This makes it easier for the bigger players to fill more orders.

Step 3 – Look for the false breakouts at the S&R level

As we know by now, most of the false breakouts happen at major support resistance area. A trader can set the alarm on the price chart to see when the price action is at a major level. When the price breaks these levels, wait for the false breakout to trade the market.

In the below image, GBP/USD was in an uptrend. On 15 Min chart during the pullback phase, prices started holding at the support area. On 29th Nov, look at the first circle where the price action prints the false breakout. But there is no way to trade that breakout. Because after that, the price action dipped below the support area, which is a sign of a false breakout. So it is an indication to go long on the GBP/USD forex pair.

Step 4 – Entry, Stop loss and Take profit

A trader should be entering the market when the price action holds at the significant support resistance area as it confirms that the levels are active to hold the prices. \

Take profit placement depends on your trading style. If you are an intraday trader, we suggest you close your position at a recent high. If you are a swing trader, look for another false breakout to load more positions. You can also use the recent high or any support resistance area of the higher timeframe to close all of your positions.

Most of the false breakouts are sure shot trades in the market. Place the stop loss just below the recent low, or at the closing of the most recent candle. If you are a conservative trader, then put stop loss bit spacious to your entry point.

In the below image, we have placed the stop loss just below the closing of the recent candle, and we have captured the 4R trade in the market.

Bottom line

It is essential to learn the logic and psychology behind any false breakout. Most of the time, the risk is small in these types of trades, and it is important not to be greedy while placing more extended targets. If there is no momentum in the market, close your positions, and if the trend is healthy to go for longer moves. You can still trade the regular breakouts, but throw relatively less money when compared to the false breakout trades. Also, make sure to practice trading false breakouts in a demo account until you master it. We hope you liked this article. Cheers!

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Forex Market

Understanding Drawdown & Its Relation With Position Size

Introduction

Do you know that there is a safe way to choose the maximum lot size when you trade? That too while keeping your account safe from blowing when a losing streak of trades occur? To constantly stay in the game and be able to recover from losses requires patience, clarity, and, more importantly – optimal Position sizing. The position size in simple words is how much a trader invests in each trade. There are different models deployed to reach the optimal position sizing depending on the objective of the trade. Before that, let’s first understand what drawdown is and how it is related to position sizing.

What is the maximum drawdown?

The maximum drawdown is the biggest drop in the accumulated profit chart and, consequently, that of the trading capital. Imagine a situation where a trader had 200 pips in profit after a number of trades, and on the following days’ profit dropped to 136 pips before he can make new accumulated high.

So, the drawdown here was 200-136 = 64 pips

When this drawdown increases, it reaches a level (negative drawdown), after which it becomes impossible to trade (due to loss of trading capital). Maximum drawdown is the loss that the trader can take in order to survive in the market and be able to continue trading.

How is drawdown related to position sizing?

Taking the above example, let us assume that the trading capital was $500 and the trader trades with a lot size of 0.01. The drawdown he experienced was 64 pips, which is $6.4 (1 Pip = $0.1). So the amount of money he/she risking in this trade is 6.4/500 x 100 = 1.28% of the account size.

Now let us see how this drawdown increases with a change in position size.

How much drawdown can I handle so that it doesn’t affect the mental state and my trading style?

As you can see below, the drawdown % increase as the lot size increases and the account gets into an unsustainable state (Especially when the Trading Capital is $500). Hence you need to calculate risk based on your risk tolerance drawdown.

The right way to look at drawdown and position size

Typically, the drawdown occurs after a series of consecutive losses. The very first thing a trader needs to do is to analyze and figure out the number of losing trader he/she can endure. Depending on that, the maximum risk percentage should be defined. So essentially, this percentage is the maximum amount of trading capital a trader affords to lose. If the losses cross this percentage, his/her account get unsustainable.

For instance, I can bear a maximum drawdown of 20%. So I should be willing to design a strategy and chose my trading size in such a way that it is very unlikely for me to reach the 20% drawdown. Let’s denote the number of losing streaks as N. I should make sure that my strategy has a winning percentage of at least 50% or more with high RRRs. Let’s assume the maximum number of losing streaks I can afford is 10 (i.e. N=10).

Dividing the maximum drawdown (20%) with N (10) gives 2%. This means that I cannot risk more than 2% of my trading capital on a trade to sustain in the market. If I have more than one open trading position, I should be distributing the risk among all of the open positions. So here, if I have 2 open positions, I shouldn’t be risking more than 1% in each of the trades. This is one of the best ways to look at drawdown and position size.

Different approaches to position sizing

Defined Percentage Risk

In this position sizing strategy, we risk a fixed percentage of the trading capital (e.g., 1%) for each trade. This is followed by most of the traders across the world and it is pretty simple to use as well. Essentially, the trader is required to put the stop-loss more accurately and not randomly to prevent the stop-loss hunt. This might sound pretty easy but it needs a lot of discipline to overcome the greed and not raise the position size when you see a clear profitable trading signal.

The Kelly Criterion Model

John Kelly described this criterion pretty long ago, which computes the optimal position size for a series of trades.

Kelly Percentage = W – [(1-W) / R)

Where, W – Winning probability and R – Profit/Loss ratio

When a trader keeps a record of all their trades, they can calculate their winning probability and profit/loss ratio. Then, they can use them in the above equation to calculate the optimal position size.

Conclusion

You now know the importance of position size and its relation to drawdown. By using this, leverage can also be used appropriately to avoid blowing-up your account because of the drawdown. By doing this, you can maximize your earnings and reduce drawdown to an acceptable value.

Our suggestion for you is to use a trading strategy for a long time. If a strategy hasn’t been tried many times, the big drawdown might not have appeared yet. The bigger the history of using the strategy, the more confidence you will get to increase the lot size. Cheers!

Categories
Forex Basic Strategies

Trading With The Bollinger Band %B Indicator

Introduction

If you have experience trading with the Bollinger Bands indicator, you will find it easy to trade with the Bollinger Band %B indicator. The only difference is that, in this indicator, you can identify the relationship between the price and the bands with at most clarity.

What is the Bollinger Band %B indicator?

It is basically a technical indicator that quantifies the price of an asset with respect to the upper and lower limits of Bollinger Bands. We have derived 6 relations between the price and the indicator.

  • The %B is at zero when the currency pair is at the lower band.
  • % B will be at 100 when the currency pair is at the upper band.
  • The indicator is above 100 when the price of the currency pair above the upper band.
  • It is below zero when the price goes below the lower band.
  • The %B is above 50 when the price goes above the middle band.
  • And it is below 50 when the price goes below the middle band.

The Bollinger band %B uses the 20-day simple moving average (SMA) as the default parameter, just like the Bollinger Bands. This indicator is available on most of the trading platforms and terminals.

Bollinger Band %B formula

%B = (Price – Lower Band) / (Upper Band – Lower band)

Things to know

Before understanding the strategy, it is necessary to know a few things about the indicator as these concepts will be used in every step of the strategy. Below is the chart of a forex pair with the Bollinger Band %B indicator plotted to it.

  • The upper dashed line represents the 100% level of the %B indicator also known as the upper band.
  • The lower dashed line represents the 0% level also known as the lower band of the indicator.
  • The area in between the two dashed lines is known as the middle band.

These bands help us in identifying different trading opportunities. Hence, one needs to know about it before knowing the strategy.

The Strategy

Step 1: Identify the major trend

To identify the overall trend of the market, the trader needs to shrink the chart and determine the trend.

An uptrend is defined as a series of higher highs and higher lows, while a downtrend is defined as a series of lower lows and lower highs. In this strategy, we have taken the example of a downtrend, as shown in the figure. One can also see lower lows and lower highs in the above chart.

Let us see how the strategy works.

Step 2: Find the price where %B is above 100 or below 0 in the currency pair.

In this step, we are looking for the price where the indicator is above the upper band or below the lower band. This extreme price action is said to continue for long after taking a suitable entry.

A sell setup is formed when the indicator crosses below the lower band, and a buy setup is formed when the indicator crosses above the upper band. This strategy is almost reverse of other strategies (as oversold indicates buying in other strategies).

The above chart shows the crossing of the indicator below the lower band, which is apt for a sell trade. Just because the price is below the dashed line, we cannot take an entry immediately.

The next step is to find a pullback and then make an entry. We will then see how and where to take profits.

Step 3: Take an entry only at a suitable pullback.

By suitable pullback, we mean the opposite color candles should not be swift candles and should not make higher highs. If this happens, the current trend can be weak and may not sustain. The %B indicator can also assist us with the same, as the indicator should move slowly after crossing the lower band. If the indicator reacts and moves fast, it means the pullback is strong and could also result in a reversal. Finally, an entry can be taken after the close of at least two pullback candles.

The below figure explains the above paragraph clearly.

Step 4: Determining how to take profit

In this strategy, we follow a rule-based system for making profits which are again based on our indicator. A trader needs to cover his position after the indicator crosses the lower band once again and goes above the dashed line. This style of taking profit is different than in other strategies where it is based on a fixed percentage. This way of taking profits ensures that a trader is trading based on rules and guidelines which is a disciplined approach.

The below figure explains how profit is taken and the position is covered.

When the indicator goes above the 0% (lower band) level after crossing below, it means profit can be taken now and the trade can be closed.

Step 5: Place a protective stop

Stop-loss is a mandatory and essential part of risk management, hence it needs to determined before entering a trade. For this strategy, stop-loss is placed above the high of the pullback which makes it an optimal place. The stop-loss, in this case, is very small which increases the risk to reward ratio (RR) considerably.

Here is exactly where it is recommended to put the stop loss.

The final trade setup would look something like this 👇

This results in a minimum of 2:1 RRR.

Final words

This is one of the easiest strategies which can be learned by new and experienced traders. It makes use of simple Bollinger bands added with a %B indicator. This indicator can also be combined with several other technical indicators and trading systems, but this alone, too, has a very good level of accuracy.  Now, we have to follow the money management principles to take the best trades and make huge profits from the same strategy. For this, you can also refer to our money management article series, which talks on various risk management topics. Cheers!

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Forex Basic Strategies

Trading Price Channels Like A Professional Forex Trader

Introduction

One of the most important characteristics of price in the Forex market is that it moves in the form of channels 20-25% of the time. So it is crucial to learn how to trade the market when it is in this state. The price channel strategy that we are going to discuss is intuitive and most straightforward. In this article, we will see how to implement this strategy and take profitable trades while reducing risk at the same time. Let’s get right into it.

What is the price channel pattern?

Before exploring the strategy, we need to know what a price channel means and the different types of channels. The price channel represents two trend lines drawn above (channel resistance) and below (channel support) the price. The price moves within these two trend lines.

The width of the channel should be big enough if you want to trade inside it. In this case, a simple trade would be to buy at channel support and sell at the channel resistance level.

However, the most significant opportunity is to trade the channel breakout.

We can distinguish the channel into two types:

  • Upward price channel
  • Downward price channel

An upward price channel occurs when price makes higher highs and higher lows. More the number of touches the price makes to channel’s support and resistance, stronger is the channel.

A downward price channel occurs when the price makes a series of lower lows and lower highs. The trend line should be able to connect to these points; only then we can call it a channel.

This represents the consolidation or ranging zone. Here the market bounces on and off between the two support and resistance lines.

If you understand the psychology and reason behind the formation of a price channel, it can save you a lot of losing trades. The reason why channel breakout is so significant is that many traders trade inside the channel. They place their stop loss above or below the price channel pattern.

As more and more traders start placing their stops, they will eventually be targeted by smart money. One needs to remember that a price channel won’t last forever. Breakout in any form is inevitable.

So, now, let’s see what the price channel strategy is and how to trade it effectively. This strategy is independent of technical indicators and does not make use of it (except for taking profits). Hence, there is no prior knowledge of technical indicators is required.

Price channel strategy

Recognize the early signs of a price channel breakout, as this will help you make better decisions. This strategy is based on such breakout signs, so knowing about them in advance is an advantage.

Here are the various steps involved in the strategy. We will be taking the example of a sell trade.

Step 1: Draw an upward channel

The upward channel should be constructed in such a way that it should connect at least two higher highs and higher lows. You can also make use of the price channel tool, which is provided by most trading platforms to connect the highs and lows.

Before the breakout, we need to make sure of an important rule, which brings us to the next step.

Step 2: For an upward channel, look for a false breakout above the channel resistance.  

In the case of an upward channel, the first warning would be the price failing at the resistance and giving a false indication that the price has broken above resistance.

Only this strategy makes use of this powerful price reading technique. It is in this unique style that we have developed this strategy. The failed attempt at the top is a sign of ‘stop-loss hunt’ by large players, which is confirmed when the price comes back to the channel support.

Note – The more times a ‘swing high‘ tries to get violated and fails, the stronger will be the breakdown.

Step 3: Wait for the breakdown and confirmation

A mistake that most traders do is that they don’t wait for a confirmation signal after the breakdown happens. For this strategy, the confirmation is to wait for the breakdown candle to close below the channel support. Before this, wait for the breakdown and then look for confirmation.

The closing of the candle should be like one in the below figure.

So, don’t just sell after the support is broken. Instead, see that the breakdown candle closes below the price channel. This is an effortless way to avoid false breakdown signals.

Note – If the breakdown candle is decisive, it’s good, but not mandatory.

Then what is the exact point of entry? This brings us to the fourth step of the strategy.

Step 4: Sell right at the closing candle

The entry technique of the strategy is quite simple. A sell order can be executed at the breakdown candle closing price.

Now you can be confident in taking the trade, as you have done everything right until now. The next logical thing to do is to determine where to take profits and place the protective stops.

Step 5: Take 50% profit at consolidation near EMA and rest 50% after price crosses above the EMA. The stop loss has to be placed above the channel support.           

We will be taking profits based on EMA plotted on our chart. Our first potential take profit zone is when the price starts to consolidate near the EMA and touches the line multiple times, as this means that the trend might be coming to an end.

The second potential take profit zone is when the price crosses above the EMA, signaling a reversal of the current trend.

Next, we need to establish our stop-loss.

The stop-loss is placed right above the price channel support, which was broken. Stop-loss can also be extended up to price channel resistance to give more room for the price.

Finally, the trade would look something like in the below figure. This trade will result in a risk to reward ratio of 1:1 minimum. However, if you are patient enough to wait for the trend to continue, the RRR can be increased.

Note – The above trade is an example of a sell trade. The same rules apply for a ‘buy trade,’ but in reverse, as this time, you will be using a downward price channel.

Bottom Line

The price channel strategy can be used in any kind of market. It can also be incorporated into your current strategy to bring a new dimension to price action trading. If you are good at spotting price patterns and money management, this strategy can make huge profits. Happy Trading!

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Forex Basic Strategies Forex Fibonacci

Perfecting The Fibonacci Retracements Trading Strategy

Introduction

The Fibonacci tool was developed by Leonardo Pisano, who was born in 1175 AD in Italy. Pisano was one of the greatest mathematicians of the middle ages. He brought the current decimal system to the western world ( learned from Arab merchants on his trips to African lands). Before that, mathematicians were struggling with the awkward roman numerical system. That advancement was the basis for modern mathematics and calculus.

He also developed a series of numbers using which he created Fibonacci ratios describing the proportions. Traders have been using these ratios for many years, and market participants are still using it in their daily trading activities.

In today’s article, we will be sharing a simple Fibonacci Retracement Trading Strategy that uses Fibonacci extensions along with trend lines to find accurate trades. There are multiple ways of using the Fibonacci tool, but one of the best ways to trade with Fibonacci is by using trend lines.

With this Fibonacci trading strategy, a trader will find everything they need to know about the Fibonacci retracement tool. This tool can also be combined with other technical indicators to give confirmation signals for entries and exits. It also finds its use in different trading strategies.

Below is a picture of the different ratios that Leonardo created. We will get into details of these lines as we start explaining the strategy.

Strategy Prerequisites

Most of the charting software usually comes with these ratios, but a trader needs to know how to plot them on the chart. Many traders use this tool irrespective of the trading strategy, as they feel it is a powerful tool. The first thing we need to know is where to apply these fibs. They are placed on the swing high/swing low.

  • A swing high is a point where there are at least two lower highs to its right
  • A swing low is a point where there are at least two higher lows to its right

If you are uncertain of what the above definitions meant, have a look at the below chart.

Here’s how it would look after plotting Fibonacci retracement on the chart.

In an uptrend, it is drawn by dragging the Fibonacci level from the swing high all the way to swing low. In case of a downtrend, start with the swing high and drag the cursor down to the swing low. Let’s go ahead and find out how this strategy works.

The Strategy

This strategy can be used in any market, like stocks, options, futures, and of course, Forex as well. It works on all the time frames, as well. Since the Fibonacci tool is trend-following, we will be taking advantage of the retracements in the trend and profit from it. Traders look at Fibonacci levels as areas of support and resistance, which is why these levels could be a difference-maker to a trader’s success.

Below are the detailed steps involved in trading with this strategy

Step 1 – Find the long term (4H or daily time frame) trend of a currency pair

This is a very simple step but crucial, as well. Because we need to make sure if the market is either in an uptrend or a downtrend. For explanation purposes, we will be examining an uptrend. We will be looking for a retracement in the trend and take an entry based on our rules.

Step 2 – Draw a line connecting the higher lows. This line becomes our trendline.

The trend line acts as support and resistance levels for us. In this example, we will be using it as support.

Step 3 – Draw the Fibonacci from Swing low to Swing high

Use the Fibonacci retracement tool of your trading software and place it on swing low. Extend this line up to the swing high. Since it is an uptrend, we started with a 100% level at the swing low and ended with 0% at the swing high.

Step 4 – Wait for the price to hit the trend line between 38.2% and 61.8% Fibonacci levels.

In the below-given figure, we can see that the price is touching the trend line at two points (1 and 2). There is a significant difference between the two points. At point 1, the price touches the trend line between 78.6% and 100%, whereas, at point 2, the price touches the trend line between 38.2% and 61.8%.

The region between 38.2% and 61.8% is known as the Fibonacci Golden Ratio, which is critical to us. A trader should be buying only when the price retraces to the golden ratio, retracements to other levels should not be considered. Therefore, point 2 is where we will be looking for buying opportunities.

Step 5 – Entry and Stop-loss

Enter the market after price closes either above the 38.2% or 50% level. We need to wait until this happens, as the price may not move back up. However, it should not take long as the trend should continue upwards after hitting the support line.

For placing the stop loss, look at previous support or resistance from where the price broke out and put it below that. In this example, stop loss can be placed 50% and 61.8% Fibonacci level because if it breaks the 50% level, the uptrend would have become invalidated. The trade would look something like this.

Final words

The Fibonacci retracement tool is a prevalent tool used by many technical traders. It determines the support and resistance levels using a simple mathematical formula. Do not always rely only on Fibonacci ratios, as no indicator works perfectly alone. Use additional tools like technical analysis or other credible indicators to confirm the authenticity and accuracy of the generated trading signals. One more important point that shouldn’t be forgotten is not to use Fibonacci on very short-term charts as the market is volatile. Applying Fibonacci on longer time frames yield better results.

We hope you find this strategy informative. Try this strategy in daily trading activities and let us know if they helped you to trade better. Cheers!

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Forex Course

24. Fundamentals Of Margin Trading

Introduction

Margin, which allows for Leverage trading, is one of the crucial reasons why most of the traders prefer trading Forex. It is an aggressive form of trading where traders take more risk while expecting an additional reward. Here, traders increase their bet by borrowing funds usually from their brokers. Thereby leverage trading allows a trader to trade with more funds than they actually have in their account. Leverage trading exists in the stock market, as well. The internal working of margin in both the markets is not quite the same, but the overall concept is the same.

Leverages is typically represented in ratios or with an ”X” next to it. For instance, the notation of two times leverage would be 2:1 or 2x. There are several other terminologies such as balance, realized and unrealized P/L, used margin, equity, etc. which are involved in margin trading. And to trade in a margin account, having knowledge about these terms is vital. So, in this lesson, some basic concepts and working of the margin trading shall be discussed.

Margin Account

A margin account, also referred to as a leverage account, is a trading account offered by a forex broker, which lets their clients trade large quantities without investing the total required amount. In a margin account, the forex broker acts like a loan lender who lends cash to its customers for taking positions in the market.

How does margin trading work?

Let us assume that a trader has deposited some amount into his account. The broker sets a margin percentage for the client. This margin percentage typically is between 1-2%. In forex, it is not the case that this account balance is used for taking a position. But, it is used up by the brokers as security deposits. Here, if the broker sets a margin percentage to 1%, then 1% of the trade value is utilized by the broker as a security deposit. So, a trader takes a position worth $100,000, then only $1,000 is used up, and the broker lends the rest 99% of the amount. This is the basic working of a margin account. There are many other terms involved in it, which shall be discussed in the subsequent lessons.

Benefits and Shortcomings of Leverage Trading

Initially, margin trading might seem very beneficial. To an extent, this is true, but there are disadvantages to it as well. Below are some of the advantages and disadvantages of margin trading.

Advantages

🟢 Ability to multiply a trader’s trade size

With margin trading, minimal capital is no more an issue because one can take larger positions even with a smaller investment.

🟢 Significant short-term gains

As margin accounts allow traders to take bigger positions, one can grow their account balance exponentially, even in the short-term.

Disadvantages

🔴 High risk

The market has two directions. So, though a trader trades on a margin, it does not mean that the trade will perform in their forecasted direction. A trader can make high profits and can even lose a significant amount of money. Hence, trading with margin involves high risk. And it is not recommended for novice traders.

🔴 The requirement of the minimum account balance

Trading in a margin account requires the user to maintain the minimum balance specified by the broker. If a user fails to maintain the minimum balance, then the trader is forced to close their positions.

This concludes the introduction of margin trading. In the next lesson, the terminologies involved in margin trading shall be discussed.

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Forex Course

23. A Brief Comparison Between The Stock Market & The Forex Market

Introduction

The Stock market and the Forex market are the most widely traded markets in the world. Many traders who enter the universe of trading are often in a dilemma on which market to trade on. Though both markets involve trading instruments, there are many differences between these two. In this lesson, we shall get insights on the different features of both markets and then come to a conclusion on which is the market has got the upper hand.

Market timings

The forex market is open for 24/5. This proves to be a considerable advantage, as traders can trade anytime during the trading hours according to their schedule. While this is not the case with the stock market because they’re open only for 7-9 hours in a day. So, the stock market timings can be helpful only to full-time traders.

Facility to buy and sell short

As already discussed in the previous lesson, there is no directional bias in the forex market. The process and working for buying and selling is the same. Hence, a trader can participate during any condition of the market.  In the case of the stock market, there are few restrictions on short selling a stock. Though the facility for short selling is available, the procedure is not as simple as buying a stock.

Leverage/Margin

Leverage is the facility provided by the brokers to take larger positions with smaller capital. Leverage is one of the reasons why small retail traders take part in the market. Now, comparing the leverage in the stock market with the forex market, the difference is quite significant. In the stock market, maximum leverage for a day trader is up to 4:1 and for a positional trader, it is up to 2:1. Coming to the forex market, the leverage is commonly around 100:1. In fact, in some brokerages, it goes up to 500:1 as well. However, it cannot be concluded that it is better to choose the forex market over the stock market. This is because, as the leverage increases, the risk involved in the trade also increases.

Dividends

Dividends are basically perks given by companies if an investor invests in their company. Investing in a stock that provides dividends to their customers can be considered as a risk-free business. This is because, even if the stock underperforms in the market, you are usually assured of dividend income. But, in the forex market, there is no concept of dividends as such. Hence, this market is for the ones who are willing to take the risk.

Diversification

Many traders look for diversifying their portfolio. In the US stock market, there are around 2,800 stocks listed on the NYSE and 3,100 on the NASDAQ. And these stocks are put into different sectors. The sectors have their specific features and perform differently from other sectors. Hence, the stock market is an ideal market for the ones looking to diversify their investments.

Conclusion

In considerations of the above features of the stock market and the forex market, it is quite hard to stay biased. In the initial features, the forex market proves to be a better market, and when it comes to dividends and diversification, the stock market is the clear winner. Hence, from this, we can conclude, ‘the best market’ is a variable factor. It all depends on the type of trader a person is.

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Forex Basic Strategies

The Most Simple Scalping Strategy To Trade The Forex Market!

What is Scalping?

Scalping is one of the trading styles in the forex market, which is gaining popularity with the emergence of artificial intelligence and automated trading systems. Nowadays, there are a set of traders who enjoy scalping than day trading, swing trading, or position trading.

The main difference between scalping and other styles of trading is that in scalping, the trading time frame is very short and face-paced. The holding period does not last more than a few minutes, whereas ‘positional’ traders hold their trades from 1-Hour to few weeks. Scalpers find trading opportunities on very short timeframes such as the 1-Minute and 3-Minutes.

Impulsive traders are the ones who are most attracted to scalping, as they don’t want to wait for a trade to set up on the higher time frame. Sadly, new traders fall into this trap and start scalping the market, totally unaware of the risk it carries.

To scalp, a trader needs to be experienced. We recommend first being consistently profitable on the higher time frame or swing trading and then move on to scalping. Because this form of trading is extremely difficult as it requires a trader to make decisions in mere seconds or minutes.

5-Minute Scalping Strategy

In this section, we’ll cover a simple yet very effective scalping strategy on the 5-minute timeframe. The most suitable time to implement this strategy is during volatile market conditions. This means the best results are obtained during the New York-London session overlap (8:00 AM to 12:00 PM EST). During this time, trading costs are also relatively low, and liquidity is high, which is essential for the scalpers to take a trade.

We will be using two exponential moving averages in this strategy. Below are the indicators that one needs to apply to their charts.

  • 50-Period exponential moving average
  • 200-Period exponential moving average
  • Stochastic indicator

The Strategy

Let us look at the detailed steps involved in the 5-minute scalping strategy.

Step 1️⃣ – Identify the current trend

The two EMAs are used to indicate the trend in the 5-minute chart. To identify the larger trend, a trader will have to change the time frame to 15-minutes. Identifying the bigger trend is crucial to understand the overall direction of the market. The 50-period EMA is much faster than the 200-period EMA, which means it reacts to price changes more quickly.

If a faster (50-period) EMA crosses above the slower EMA (200-period), it means the prices are starting to rise, and the uptrend is more likely to be established. Similarly, a cross of faster EMA below the slower EMA indicates a drop in the price, and that also means a downtrend is about to form. Always make sure to take trades in the direction of the major trend.

Step 2️⃣ – Look for a pullback

Once we determine the current trend on the 5-minute chart based on EMA’s, it is time to wait for a pullback and stabilization of the price. This is one of the most important steps in this strategy as prices tend to make false moves after strong ups or downs. By waiting for the pullbacks, we can prevent ourselves from entering long or short positions too early.

Step 3️⃣ – Confirmation with the Stochastic Indicator

Finally, the Stochastic indicator gives the confirmation signal and helps us to take only highly-profitable trades. A reading above 80 indicates that the recent up move was strong, and a down move can be expected at any time. This is referred to as the overbought market condition. Whereas, a reading below 20 indicates that the recent down move was strong, and an up move is about to come. This market condition is referred to as the oversold market condition. After a pullback to the EMA’s, the Stochastic Indicator’s final confirmation gives us the perfect trade entry.

Let us understand this strategy better with the help of an example.

Chart-1

The above figure is a 5-minute chart of a currency pair, and the 200-period EMA is represented by the orange line while the 50-period EMA is represented by the pink line. The cross of the pink line above the orange line signals that the currency pair is entering into an uptrend on the 5-minute chart. As long as the faster EMA remains above the slower EMA, we’ll only look for buying opportunities. This step is to identify the direction and crossing of the two EMAs.

Chart-2

A trader shouldn’t be going ‘long’ as soon as they see the lines crossing. They should always wait for the pullback and only then take an entry. In ‘chart-2’, when we move further, we were getting the kind of pullback that we exactly need.

The next question is, at which point to buy?

Chart-3

The Stochastic plotted in the above chart helps in giving us the perfect entry points by getting into the oversold area. One can take a risk-free entry after all the indicators support the direction of the market.

Chart-4
Finally, the trade would look something like this (chart-4). The risk to reward ratio (RRR) of this trade is 2:5, which is very good. Also, make sure to place precise stop-loss and take profit orders, as shown above.

Final words

Scalping is a faced-paced way of trading that is preferred by a lot of traders these days. The main difference between scalping and other styles of trading is the timeframes involved in analyzing the market. This type of trading carries certain risks that are unavoidable, such as high trading costs and market noise, which can impact your profits. We hope you find this article informative. Let us know if you have any questions below. Cheers!

Categories
Forex Basic Strategies

Understanding The Volatility Breakout Strategy

Introduction

Breakout trading is one of the most common and popular strategies among traders across the world. In this article, we have added a powerful concept to this strategy, which is volatility. In a volatility breakout, we determine the movement of prices just before the breakout and also their reaction at important support and resistance levels. After analyzing the market, we will decide which breakout is safe to trade and which is not.

Volatility cycles

We have built the volatility breakout strategy in a very simple way. The principle of this strategy is that, when the market moves from one level to another (support to resistance or resistance to support) with strong momentum, the momentum is said to continue further. The other characteristic of the price is that it moves from periods of sideways movement (consolidation) and vertical movement (trend).

Price breaking out of a consolidation prompts us to believe that price will continue in that direction, which might last for one day, one week, or one month. The market after trending downwards gets choppy and reduces directional movement. Traders can use technical indicators like Bollinger Bands, which helps them to determine the strength of the breakout. Breakouts that happen with low volatility are ‘real’ breakouts; on the contrary, breakouts with high volatility can result in a false breakout. We shall look at each case in detail in the next sections of the article.

 

High volatility breakout

When we are talking about volatility, we mean the choppiness of the price, i.e., the back and forth movement of price. There are traders who like this kind of volatility, as they feel price moves very fast from one point to another. But this isn’t necessarily true in case of a breakout. If you don’t have the required strength in a breakout, you could be trouble.

In the above chart, we see that the price has been in a range for a long time. This means a breakout could happen anytime. Much later, the price tried to break above resistance and stayed there for quite a long time. The price is just chopping around without moving in any particular direction eminently. All these are indications that the breakout, if it happens, will not sustain. Hence, one needs to be extra cautious before going ‘long’ after the breakout.

There are many traders who are willing to take the risk and want to try their luck in such conditions. In that case, after you buy the forex pair, always keep a tight stop loss. The reason why we are suggesting a tight stop loss is that there are high chances for the trade will not work in your favor, and you should avoid making a big loss in that trade. The setup would look like something below.

If the trade works, it can give a decent profit with risk to reward of more than 1.5, which is really good. Again this strategy is only for aggressive traders.

Low volatility breakout    

When a breakout happens with a lot more strength, it is said to be a low volatility breakout. The price here does not face much of hurdle and crosses the barrier with ease.

As you can see in the above chart, the price does not halt at resistance, and the breaks out smoothly, which is exactly how a breakout should be. After that, you can see that the breakout happens successfully, and the price continues to move higher. When such type of volatility comes into notice, we will see a higher number of traders being a part of this rally because they are relatively risk-free trades. This strategy is recommended by us to all types of traders, irrespective of their risk appetite. The next question is where to take profit and put a protective stop.

Stop-loss can be placed below the higher low, which will be formed near the resistance, and profit should be booked at a price which will result in a risk to reward ratio of 1:2. Some money management rules should also be applied while booking profits. The setup would look something like this.

Measuring volatility

Since this strategy is mostly based on volatility, it is important to know how to measure volatility.

  • Bollinger bands are excellent volatility and trend indicators, but like all indicators, they are not perfect.
  • Average true range (ATR) measures the true range of the specified number of price bars, typically 14. ATR is a volatility measuring indicator and does not necessarily indicate a trend. We see a rise in ATR as the price moves from consolidation to a strong trend and a fall in ATR as market transitions from strong trend to choppiness.
  • ADX is also a prominent indicator that measures the strength of a trend based on highs and lows of the trend over a specified number of candles, again typically 14. When ADX rises, it indicates that the volatility has returned to the market, and you might want to use a strategy that fits that market condition.

Bottom line

The market does not always be in trending and consolidation phases, and we also have to learn to deal with different types of volatility. This is where most of the strategies can be used at their best, and using volatility indicators can help you trade more effectively. A breakout, when accompanied by the right amount of volatility, can be highly rewarding. Hence this is an important factor in any breakout trading system. Cheers!

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Forex Basic Strategies

Understanding The N-period Narrow Range Trading Strategy

Introduction

There are three states in the market – trend state, channel state, and range state. A trending market is the one where the market makes higher highs or lower lows, and a ranging market is a state where the price goes through a consolidation phase. The channels can be considered as a particular case of range as they work similarly to a range, but are tilted.

What is consolidation?

To understand this strategy, we must first understand the concept of consolidation. Consolidation is a technical term in trading where the market loses momentum and starts to move in the form of a range.

A common tendency of the market is that, when the price starts to move in a range and begins to consolidate, it prepares blast in one of the sides. So, people always keep an eye on currency pairs, which are in a consolidation phase.

N-Period Narrow Range

In the N-period narrow range, the period N takes two values –4 and 7. So, we have the 4-period narrow range and the 7-period narrow range. These two are also referred to as the NR4 (Narrow Range 4) and the NR7 (Narrow Range 7).

The NR4 and NR7 trading strategy

This strategy is basically a modified range breakout strategy where the market consolidates in the beginning and then blasts out of a narrow range.

In NR4, number 4 refers to the period under consideration. That is, for NR4, the last four days are taken into consideration, and for NR7, the last seven days are taken into account.

What is the NR4 and NR7 strategy?

It is a breakout trading technique where we consider the last four or sever days to apply this strategy. And in these four or seven days, we compare the range of all these days and determine if the current day is an NR4 or NR7 day. Once we obtain the NR4 or NR7 day, we gear up to go long or short.

Calculating the range

Firstly, to trade this strategy, consider the candlestick chart on the daily timeframe. The range of a particular day is calculated as the difference between the high price and the low price.

What is the NR4 day and the NR7 day?

NR4 day

In layman’s terms, the least fluctuated day (4th day) in the recent four days is called the NR4 day. Technically, it is the day whose range is the smallest out of the previous four trading days.

NR7 day

Similarly, when the 7th day in the last seven days moves the least number of pips, it is referred to as the NR7 day.

How to trade the NR4/NR7 strategy?

Following is a set by step procedure to trade this strategy:

  1. Find the high and low of the last few days (seven for NR7 and four for NR4).
  2. Calculate the range (high – low) for each day under consideration.
  3. Compare these range values with the previous days.
  4. Determine if the present day is an NR4 or NR7 day. If so, then wait for the price to break out of the high or low of the NR4/NR7 day.

If the market breaks above the high, then it is an indication for a buy, or if it breaks below the low, then it is an indication for a sell.

Illustration to trade the N-period Narrow Range

Trading the NR4/NR7 strategy is simple. But, as far as the consistency of this strategy is concerned, one can make more out of this strategy only when the NR4/NR7 day appears in the right location. Hence, understanding ‘where’ the NR4/NR7 occurs is very vital. So, let’s consider a few examples to support this statement.

Below is the chart of USD/CAD on the Daily timeframe. We can clearly see that the market is moving in a channel state. Now, to trade this strategy, we blend it with the working of a channel.

Trading a channel is pretty straightforward. When the price is at the bottom of the channel, we look for buying opportunities, and when it is at the top of the channel, we look for short-selling opportunities. With this mind, we try spotting the NR4/NR7 days in these regions.

Below is the magnified image of the chart where we’re going to analyze the market. Initially, the market came down rolling until the bottom of the channel and began to hold down there. And the candle which held at the bottom turned out to be the NR7 day as it has the smallest range compared to the previous six days. This is an indication that the market (sellers) is slowing down. Later, the market blasts up north and breaks the high of the NR7 day. Therefore, now we can prepare to go long.

And as we can see, the trade performs exceptionally well. This is because the location was in favor of the NR7 day.

Continuing with the same chart, the market which was at the bottom of the channel now moves up to the top of the channel. During this up move, the market loses its momentum every step of the way and ends up giving us the NR4 day at the top of the Channel. Hence, once the price breaks below the low of the NR4 candle, we can go for the short sell. And as a result, the market does break through the NR4 day and heads down south.

Bottom line

Trading in the markets is not an easy task. There is no indicator, pattern, or strategy that can consistently work standalone. There are several other considerations that should be made before getting into a trade. For example, in the above trades, we saw how we combined the NR4/NR7 with the concept of channels and made a profit from them. Also, for any strategy, you trade, make sure that there is logical reasoning behind taking the trade. We hope you find this strategy informative. If you have any questions, please let us know in the comments below.

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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!

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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.

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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 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