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Forex Basic Strategies

You Must Know This ‘7-Day Period’ Forex Trading Strategy!

Introduction

Trying to pick the top or bottom is one of the favorite things a trader likes to do. We tried to do that using the ‘Dolphin Strategy.’ We did that with no indicator support. We are again going to unveil a strategy that does pick a top or bottom with no indicator support. This strategy is called the 7-Day period strategy. Let us take a step back and think, indicators are nothing but a mathematical representation of prices, which are calculated in different ways.

Therefore, sometimes it is important to look at prices alone. The 7-day period strategy is based on the idea that after every seven days of consecutive strength, a currency pair’s move is due for a retracement. The question arises, why seven days? This number is derived after constantly watching the market for years. Often, a new trend emerges at the beginning of the week, and if the trend is strong, it can last for several days with no retracement.

Many psychologists believe that human beings have the best retention rates on numbers that are in groups of seven or less. This is one of the reasons why phone numbers in the U.S. only have seven digits, aside from the area code. We have seen that the seven-day reversal pattern is more accurate in a trending market. We gave occasionally seen those periods when the market continues to move in the same direction after seven days of the exhaustive movement, i.e., from the 8th day onwards. Even though the setup is rare, when it does occur, it is significant.

Time Frame

As the name of the strategy suggests, it can be traded only in the daily time frame.

Indicators

In this strategy, no indicators are used. Simple Moving Average (SMA) can put on the chart to get a clear idea of the trend.

Currency Pairs

This strategy can be applied to all the currencies in the forex market. Exotic pairs should be avoided.

Strategy ConceptĀ 

The basic idea of the strategy is that when the market is strongly trending on the hourly chart, the retracement does not last more than seven days and changes its direction at the sixth or seventh day. This retracement is considered to over-extended, which leads to a strong reversal in the pair.

If the sixth or seventh candle coincides with a key technical level, the ‘move’ may very well stall at that level and continue its major trend. To implement the strategy effectively, we need to know trends and trend retracement. Since this strategy is based on fixed rules and price action, it is not necessary to know about technical indicators. However, SMA and ATR can be used for trend identification and measuring the momentum of the market.

Trade Setup

In order to understand how the strategy works, we will apply it on the USD/CAD currency pair and execute a ‘short’ trade using the strategy.

Step 1

The first step is to identify the direction of the market. As this is a trend trading strategy, we should be able to identify the major direction of the market. If the market is making higher highs and higher lows, it is an uptrend, or if the market is making lower lows and lower highs, it is a downtrend. A trend can also be determined using the Simple Moving Average (SMA) indicator. Very simply, if the price is below SMA, we say that the market is in a downtrend, and if the price is above the SMA, the market is said to be in an uptrend.

In the example we have considered, from the below image, it is clear that the market is in a strong downtrend.

Step 2

Next, wait for a retracement from the highest or the lowest point, which we will be evaluated based on our strategy rules. The retracement should be such that there are seven consecutive candles of the same color. One or two candles of the opposite color are okay, but we need to make sure that it does not impact the structure of the retracement. These seven candles represent an extended pullback, which can lead to reversal any moment.

In the below image, we can see seven days of the up movement, which is exactly the kind of retracement which we need for the strategy.

Step 3

In this step, we need to check the position of the price after seven straight days of the movement. The strategy works best if the price coincides with a key technical level of support and resistance. This is because, in these areas, the price action is very strong, and market moves as per expectations. But it is important to make sure that no step of the strategy is used individually. All of them need to be used collectively.

We enter the market once we get confirmation after the 7-day period. The confirmation is nothing but a bullish candle in case of a ‘long’ setup and a bearish candle in case of a ‘short’ setup.

In our example, we see that the price has approached the previous ‘lower high’ of the downtrend. This is an area where we can expect sellers to get active and take the price lower.

Step 4

Finally, we need to determine the ‘stop-loss’ and ‘take-profit‘ for the strategy. We place the stop-loss a little higher than the bullish candle when entering for a ‘long’ and little lower the bearish candle if entering for a ‘short.’ We take profit at two places in this strategy. The first take-profit is set at the previous higher high or lower low, while the second take-profit is set at 1:2 risk to reward.

Strategy Roundup

As there are many conditions associated with the strategy, the setup might be rare, but when it does occur, it is significant. We have seen trends where the retracement occurs for just a few days before it starts moving in the direction of the major trend. But these setups are not reliable. The most important condition of this setup is the continuous appearance of bullish or bearish candles for seven days.

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Forex Course

76. Using Moving Average As Dynamic Support & Resistance

Introduction

In the previous article, we saw how moving averages could be used to find potential trade setups that are essentially based on trend reversal. The next fascinating use of the moving average is that they act as crucial Support and Resistance levels. We know the importance of Support and Resistance levels in technical analysis, and we learned how many indicators can be paired with these levels to generate potential trades.

But in the case of moving averages, this indicator itself acts as a potential support and resistance areas. We need to remember that these levels keep changing as and when the market changes its direction. That is why these levels are known as dynamic support and resistance levels. In this article, let’s understand this concept clearly.

In the below chart, we can see that the market repeatedly takes support at 50-Period EMA and then continues its uptrend.

From the above chart, we can also notice that the price at times is going below the EMA before bouncing off. Also, some times, the price is not precisely touching the EMA. In some cases, it is also possible that the market can just crash downwards without respecting our EMA line.

To overcome this problem, we should plot more than one EMA on the chart and then buy or sell once the price is in the middle of the two moving averages. We can also refer to this as the ‘trading zone.’ Let us see how the above chart will look after plotting another EMA on it.

After plotting 100-period EMA on the chart, we can see the price entering the areas between two MAs before going up and does not even touch the second MA. This means moving averages should never be used as single line support and resistance levels; rather, it is a ‘zone’ from where the market has a high chance of reacting.

When we use the concept of ‘zones,’ we get a clear idea of where to put the ‘stop-loss’ and ‘target.’ For example, the ‘stop-loss’ can be placed below the second MA, and ‘target’ could be the new higher high. When we have such a wide area for our ‘stop-loss,’ there is less chance of us getting stopped out before the trade performs in our favor.

Role Reversal of moving averages as Support and Resistance

Now that we know how moving averages act as support and resistance levels, we need to check if follows all the rules of S&R. One of the most significant rules of S&R is support turning Resistance and vice versa. We shall see if MAs follow that.

Below is a chart that shows how the moving average turns into Resistance after it was previously behaving as support. The yellow-colored arrow marks the point where the price broke through and crashed. Later, it started acting as a dynamic resistance level.

Conclusion

Using moving averages as support and resistance levels can be highly profitable when done with proper trade management. Intraday traders mostly use this technique as they fear of getting stopped out due to spikes. The best part of this application of the moving average is that they’re dynamic, which means we just need to plot them and leave it on the chart. We don’t have to keep looking back to spot support and resistance levels. In the next article, we will summarize all that we have learned about the moving averages. Cheers.

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Categories
Forex Course

73. Simple vs. Exponential Moving Average

Introduction

After having a fair amount of discussion concerning Simple and Exponential Moving Averages, a question that may arise is, which one to use when? Whether SMA gives accurate trading signals, or is it the EMA that is more accurate and reliable than SMA? Let’s try answering these questions in this article.

We mentioned in the previous article that the EMA responds to price action more quickly. So, if we want to determine a short-term trend, EMA is the best way to go. It can undoubtedly help us in catching the early move of a trend and, in fact, profit from it by taking suitable positions in the market. The downside of the EMA is that it gives us the wrong signals during the consolidation periods of the market.

Since the EMA responds very quickly to price movements, we might think that the price has broken out of the range while it could just be a spike. The EMA proves to be too fast, and this is not desirable in such market scenarios.

In the below chart, we see that the market starts to ‘range’ after a retracement of the big downward move. Due to this, the EMA starts moving up, indicating a buy signal. Later, when the last but one candle of the range breaks out above the range, traders might think that the market has reversed, as this is also confirmed by the EMA. In the very next candle, the price makes a long wick at the top of the candle, and the EMA takes a sharp turn on the downside. This is one of the examples where the EMA can give us false signals.

The opposite is true with Simple Moving Average (SMA).

The SMA should be used when we want the moving average to be smooth and respond to price action slower than the real price movement. This characteristic is particularly useful when we are trading longer trading frames, such as daily or weekly. Since SMA responds slowly to price movement, it can possibly save us from such fake outs.

The below chart represents the weekly chart of a Forex currency pair where we can see the SMA moving up even after the occurrence of the spike. Hence the SMA gives an idea of the overall trend by filtering out spikes.

Conclusion

The SMA should be used when we want to protect ourselves from fake-outs and predict the price movement in the longer term. By using SMA, we might miss the opportunity of getting in on the trend early. On the other hand, the EMA is quick to predict the trend, and thus we can be a part of the initial move of the trend. But it carries the risk of getting preoccupied with fake-outs.

The answer to the above question (which one is better?) is that it really depends on the type of trader we are. Our risk appetite, trading time frame, and strategy will influence the type of moving average we should choose. In the upcoming lessons, we will learn how to use moving averages to determine the trend and take a trade. Stay Tuned.

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Categories
Forex Course

71. Basics Of Simple Moving Average

Introduction

In the previous lesson, we understood the definition of Moving Average, their importance, and the significance of ‘length’ in MAs. We also learned the correct way of choosing the ‘length’ while using Moving Averages. In the upcoming articles, we shall see and understand the different types of moving averages. Let’s start off by learning the first type – Simple Moving Average (SMA).

Simple Moving Average

The SMA is a very simple Moving Average that is calculated by the summation of the last ‘n’ period’s closing prices and then by ‘n.’

Let us understand the above formula with an example.

When we plot 10 ‘period’ SMA on a 1-hour chart, we add the closing prices of the last 10 hours, and then divide it by 10. Similarly to plot a 5 ‘period’ SMA on a 4-hour chart, we need to add the closing prices of the candles in the last 20 hours and then divide that number by 5. These calculations are coded and embedded in the form of indicators. These indicators will be available in almost all of the trading platforms. All we need to do is to pick the indicator from the tools bar and plot them on the charts by selecting the appropriate period and timeframe.

In the below chart, we have potted three different SMAs on the chart. This chart represents the 1-hour time frame of a currency pair. As we see, longer the period of SMA, more it lags behind the price. This explains the reason why the 60 ‘period’ SMA is farther away from the 30 ‘period’ SMA; because the 60-period SMA adds up the last 60 periods and divides it by 60 as mentioned above.

When the period of an SMA is large, it reacts slowly to the price movement. Essential, SMA shows the overall sentiment of the market at any given point in time. However, SMA should always be used to find the direction of the market in the near future but not take trades based on this information alone.

Instead of looking at the current price of the market, we need to have a broader view and predict the direction of the future price movement. Using SMA, we can say if the market is in an uptrend, downtrend, or if it is moving sideways.

One major drawback of SMAs is that they are vulnerable to spikes. So, during the calculations, the prices of the currency pair, which is of no significance (high or low of spike), will be added up and shown by the SMA line. The reason behind less significance to the prices of spikes is because they give false signals, and we might think a new trend is developing, but in reality, it is just a failure of the price.

The below figure shows how the SMA would be when there are too many spikes in the chart. As we can see, the 10 ‘period’ SMA is not uniform and is not able to show the direction of the market in the occurrence of spikes.

Conclusion

The SMA should be plotted to know the market trend when it is not clear. It can also be used to forecast the price movement in the near future. It is very important to combine this indicator with a trading strategy as it can never produce the results when used standalone. In the next lesson, we shall introduce another type of moving average and see how it can solve the issues we face with SMA.

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