are usually in operation 24 hours a day from Sunday at 5 P.M. (EST) throughFriday at 4:30 P.M. (EST).When trading by phone, dealers will quote the same tight spreads available by dealing platform. All trades executed by phone are subject to a predeal margin availability check and will be entered manually into thecustomer’s account for integrated profit and loss (P&L) analysis andreporting. All telephone calls are recorded for the safety of both parties.
SOFTWARE AND DATA FEED FROM eSIGNALWith Version 7.0, eSignal began a process of turning the standard set ofbasic studies that were offered traditionally as part of the eSignal softwarepackage into a set that has a more robust user interface featuring customizable scaling, a wide array of user-friendly drawing tools, and the ability toaccommodate user-defined studies.The advanced charting versions of the line, bar, and candle charts werethe logical choice for this “starter set” because of the very nature of theircharting function—to make graphic representations of market activity—inother words, to create pictures from the numbers.Figure 5-1 presents a sample of the quality charts that eSignal offers,and it is the software I chose for demonstrational charts for this book. I knowthe people at eSignal out in California, and they make a great product. Theyare very interested in seeing that all their clients are successful investors.
4X MADE EASY 5.0 SOFTWARE4X Made Easy is a powerful charting and instant trend analysis tool thatreceives real-time foreign currency price data and updates directly over theInternet. 4X Made Easy boasts a winning combination of high-qualitygraphics matched with a complete set of money management analysisfunctions for almost any trade style. 4X Made Easy’s on-screen arrows andnext-generation buy/sell lines are the definitive directional-analysis toolsfor 4X Made Easy traders.
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FIGURE 5-1 GBP/USD Daily Minute Chart 2003
4X Made Easy 5.0 is perfect for the novice or master trader. 4X MadeEasy provides real-time tracking and analysis of the top currencies in theworld without the use of complex charts and graphs. Instead, its unique andsimple green arrow, red arrow color indicator system identifies trends aswell as possible entry and exit points.This is the software that I founded. It was a dream of mine to havesomething that could allow individual investors easy access and trade ability to the FOREX (see Figures 5-2, 5-3, and 5-4).
CONTINUING EDUCATIONWorld-class traders are always continuing their trading education. As youmaster the trading methods in this book, you will want to continue to educate yourself in FOREX trading.I offer continuous online training as well as my national radio show,live daily Monday through Friday. Check the www.JamesDicks.com Website for more information or listen to the radio show streamed live via theInternet. Come join me and ask your questions online. I look forward toyour questions.You can also go to www.premieretrade.com where there is live andarchived online training for the FOREX and other investment subjectsevery day.
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FIGURE 5-2
4X Made Easy Trading Screen
FIGURE 5-3 4X Made Easy Chart Screen
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FIGURE 5-4 4X Made Easy Trade Vault
There are, of course, many other books to choose from, just not a lotabout the FOREX. The more you read, the better it will be for your tradingexperience. A little secret from my past experience to note: First, all financial markets have inherent risk. You will not make money on every trade nomatter what you use to trade with or how well you can trade. Trading is nota sprint but a marathon.I have always believed that winning is contagious, whether hitting a baseball, trading, or whatever you may do. If you are placing trades and you arewinning on all your trades, take advantage of that and make some money.The same holds true when you make a bad trade and lose money. If itcontinues, take a step back, go for a walk, turn off the computer, and comeback later. I know traders who will log off their real accounts and log ontoa demo account and trade their demo account until they start making winning trades again. Whatever you do, just remember that it is a marathon.
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FUNDAMENTALSOF TRADING●
Introduction to Trading Theory
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Trends Defined
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Trend Cycles
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High-Probability Trading
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Sideways, Nontrend Strategy: Wait for Strong Trends
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Uptrend Trading Strategy: Buy at Dip Bottoms
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Downtrend Trading Strategy: Sell at Rally Tops
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Symmetrical Triangle
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Ascending Triangle: A Bullish Continuation Pattern
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Descending Triangle
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The Falling Broadening Formation
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Support Breakdown or Resistance Breakout
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The Double Bottom
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Head and Shoulders (Crown)
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Copyright © 2004 by The McGraw-Hill Companies, Inc. Click here for terms of use.
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INTRODUCTION TO TRADING THEORYThe trading maxim “The trend is your friend” is as true today as it has everbeen. The foreign exchange market (the FOREX) has long been recognizedas one of the most consistently trending markets of all. There are trend-following opportunities for every trading time horizon. Look at a weekly ordaily chart of any major cross-rate, and you will see trends that last severaldays, weeks, months, or even a year or more.Technical traders have long acknowledged the value of markettrends in profitable trading. As far back as the early 1900s, successfultraders wrote about trends. Here is a quotation from one such earlytext, Reminiscences of a Stock Operator, by Edwin Lefevre. Reminiscences of a Stock Operator (John Wiley & Sons, Inc., New York, FirstPub. 1923, this ed. 1994). This is the story of Jesse Livermore and wasfirst printed in 1923. It is still considered to be a classic and a mustread.I began to realize that the big money must necessarily be in the big swing.Whatever might seem to give a big swing its initial impulse, the fact isthat its continuance is not the result of manipulations by pools or artificeby financiers, but depends upon basic conditions. And no matter whoopposes it, the swing must inevitably run as far, and as fast, and as long asthe impelling forces determine.Obviously the thing to do was to be bullish in a bull market and bearish in a bear market. Sounds silly, doesn’t it? It took me a long time tograsp that general principle firmly before I saw that to put it into practicereally meant to anticipate probabilities.
Despite the universal acceptance of this concept, despite the historicaland experiential proof that it is the single most profitable trading tool, anddespite the ease with which one can spot an ongoing trend and a reversal(the inception of a new trend), doing so remains the most difficult thing formost traders to do. Why? I believe that the problem is often two-sided, inthat it is most likely a combination of psychological and technical deficiencies to varying degrees, depending on the individual trader’s systemapplication. This is the impediment that makes it so difficult to use trendsin the profit-taking formula.The psychological side may involve excessive fear, greed, or both. Thetechnical-deficiency side may be a failure to learn a trading system well ornot having the patience and discipline to execute it flawlessly.
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TRENDS DEFINEDPrice trends are market conditions in which price movement is consistently rising or falling. The market condition opposite to trends is asideways market in which highs and lows are approximately the samelevels.A trendline is a straight line joining a series of price tops or bottomsthat represents an area of support or resistance. Generally speaking, areversal in a trend or a slowing down of the pace of a trend is indicatedwhen the trendline is penetrated significantly. Trendlines should connectbottoms on a rising graph and tops on a falling graph (see Figure 6-1).InterpretationThere are several points to consider in judging the penetration of a trendline. The number of times the price touches the trendline is significant.The larger the number, the greater is the support or resistance. Thelength of the trend is important. If the series of tops or bottoms coversonly 3 to 4 weeks, the trendline is a minor one, and penetration is of littleimportance. However, if the trend covers several months or years, penetration of the trendline is viewed as a major occurrence. The violation ofa very steep trendline is of less importance than that of a slower, moregradual one.
TREND CYCLESMarkets are in a constant state of balance and imbalance. They makeimpulse moves and then correction moves. We may refer to these moves aswaves. We will see impulse waves and correction waves as markets move intrends. When market prices are flat, they usually have reached a temporarystate of equilibrium.While we look for trends on a long-interval chart, every trend consistsof smaller price movements or waves. These smaller price movements canbe categorized in order to identify the highest probability wave in which totrade with the trend.These market conditions include channel breakout, vector (strong)trend, countertrend, weak trend, and nontrend. Whether you look at a longinterval chart or a short-interval chart, you will find all these market conditions to one degree or another.
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FIGURE 6-1 GBP/USD 180-Minute Chart 2002–2003
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HIGH-PROBABILITY TRADINGThe highest probability trading will be in agreement with the strong-trendportion of the trendline found on a long-interval chart and then usingshorter-interval charts to find preferred entry and exit zones for trades. Inshort, this is continuance trading: finding an established trend and tradingthe continuance, or waves, of that trend.Therefore, the best strategy is to trade continuances in agreement withthe underlying trend or swing found on long-interval charts. If the marketis thrusting up, buy dips. If the market is thrusting down, sell rallies.
SIDEWAYS, NONTREND STRATEGY: WAIT FOR STRONG TRENDSGenerally speaking, I avoid trading in narrow sideways trends. If youobserve a wide sideways trend on a long-interval chart, where smallertrends are found moving from the bottom of the sideways range to the topand then from the top down to the bottom, it is possible, with some qualification, to trade those moves using short-interval charts.On a short-interval chart, these moves appear as short trend movesoscillating between a distinguishable top and bottom price range (See Figure 6-2).
UPTREND TRADING STRATEGY: BUY AT DIP BOTTOMSAs with all strategies it is how you manage it that counts. A strategy thatworks in upward trending markets is buying on the dips at the bottoms.What I mean by this is that nothing goes straight up, often times you willsee a stock or position go up and then start to recycle, with a reverse orprofit taking.If the position is going up nicely and you are looking at a price chartyou will see the bars (up-ticks) continue to move upwards. If you see theprice chart all of a sudden start to move in the downward range you have achange in direction. Look at Figure 6-3. If we say that this is a daily pricechart then each one of the bars black or white represent a day’s worth oftrading activity.So in this case you will see that the position has an long-term trend ofmoving up. Along the way a few road bumps. In this example you really donot see any trend reversals, this is when the price chart will actually showthe position heading as much down if not more than upward.
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FIGURE 6-2 GBP/USD 180-Minute Chart 2003
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If you look at Figure 6-3 you will see from left to right that the positionis consolidating or moving sideways. Often times when you see a positionmoving sideways and it is at the bottom of the screen the position is looking for direction. Usually the position will go up from here. Consolidationof moving sideways is just that. The overall direction of the bars or dailyprice is really not going up or down but just kind of sitting there in a range.A range is when the position is say going up to 12 dollars and down to 10dollars but no further away up or down from those prices.When you see the consolidation happening at the top of the chart it isusually looking for direction and is often times overbought and will move ina downward direction. Overbought is when you have to many buyers and nosellers. Now there is no more room for it to go up and no one is selling. Ashift will usually take place in the direction as profit taking will kick in.Profit taking is just that investors start taking their profits because theposition has gone up nicely over a period of time say daily, weekly, monthly,or yearly. Let’s look at figure 6-3 again and follow along form left to rightagain. You will see the consolidation period (sideways) movement and thenthe position finds direction; the buyers start to buy more than the sellers arewilling to sell and you have the supply and demand game. That drives theprice up until it hits resistance. Often times investors miss the first opportunity to get in on the position when it takes off from its consolidation period.So you have the first run up and profit taking kicks in. The buyers startselling and the sellers start to outweigh the buyers and the position starts togo down. If it is just normal profit taking the position will go down lookingfor some support. The support is simply where the buyers think there is agood deal and start buying again. We will cover support in more detail. Allof a sudden you have more buying than selling and the position starts to goup again; at this point you will see the chart start to move back in a positivedirection. It is at this time a dip has occurred and you have an additionalopportunity to buy back in.Now looking in Figure 6-3 you will see a long run-up period were theposition just looks like it is going straight up. There really are no opportunities to get back in as there are no definable dips in the price. And if youlook at the top just to the left you will see that as the position seems to havehit some resistance it starts to consolidate a bit. The price moves sideways.Some investors will see this as a small dip in price and an opportunity to getin the position. What usually happens is that the position will move upslightly and then correct a bit before going back up.The difference between profit taking and correction is that profit taking is usually only for a brief period and the position will move down
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toward its near term support (not very far from its last high). A correctionis where the position has run up pretty strong and then turned around significantly not enough to change the overall direction of the trend butenough to give back a large portion of your profits. This is one reason thatI really talk about money management. Good money management will protect your downside when the position goes into a correction. A correctioncan be classified as a percentage of the last move up to what it can beexpected to go down. So if the position goes up say 10 dollars and then goesback down 5 dollars before going back up again you would have had a 50percent retracement.So buying on dips gives an investor numerous opportunities to add totheir positions or get in on the trade.Figure 6-3 illustrates this concept.
DOWNTREND TRADING STRATEGY: SELL AT RALLY TOPSSelling on rallies is really the exact opposite of buying on dips. The trend isgoing down instead of going up. When the position starts to move upwardit is retracing, or profit taking just in the opposite way as the previousexample showed. So when the position moves up and starts to go backdown you can add to your positions on the short side. Going short is justselling before you buy.In the FOREX it is a little different than shorting a stock. You are onlytaking the other side of the trade. Say you were looking at the EUR/USD. Ifyou wanted to short it, you would say sell. This is what you would do if youthought the U.S. dollar was going to get stronger. Essentially what you aredoing is really buying dollars and selling euros. So as not to confuse youjust think of it as buying and selling. When the EUR/USD is going up, youbuy and when the EUR/USD is going down, you sell.Figure 6-4 illustrates this strategy.
SYMMETRICAL TRIANGLEThe symmetrical triangle is the most prevalent of the triangle patterns. Itmay be considered to be both bearish and bullish and is found in bothuptrends and downtrends.One difference from other triangle patterns is that the breakout likelycan go either way but usually aligns with the prevailing trend, as opposed tobullish ascending triangles or bearish descending triangles.
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FIGURE 6-3 EUR/USD Daily Chart 2002–2003
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FIGURE 6-4 USD/CHF 180-Minute Chart 2002–2003
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The symmetrical triangle is a formation that is also considered a consolidation period. Sometimes in a downtrend or uptrend it acts as a midpoint to a continuation of the pattern.Sometimes symmetrical triangles even form as reversal patterns at theend of a trend, but typically they are continuation patterns. Regardless ofwhere they form, symmetrical triangles are patterns worthy of watchingbecause they indicate that buyers or sellers are at a standstill and waitingfor a catalyst that could make the currency pair break out to higher or lowerprices in the short term.
RULES OF THE SYMMETRICAL TRIANGLEFigure 6-5 illustrates the rules of the symmetrical triangle.Trend. Found both in an uptrend and a downtrend.Shape. The bottom trendline placed across at least two points mustmake an upward-sloping line. The lows do not have to be a wholelot higher but should be noticeably higher than others (so otherswill see it also). There should be a few days to a few monthsbetween the proximal lows. The upper descending trendline isformed by at least two high points connected by a trendline thatangles downward and to the right. These highs should be successively lower, and there also should be a few days to a few monthsdistance between the lows. There must be at least four points touching the trendlines, but there can be many more than four total.Duration. The length of the pattern can range from a few weeks tomany months, with the average pattern lasting from 1 to 3months.Volume. As the pattern develops, volume usually contracts. When thedownside breakout occurs, there is usually stronger volume toconfirm the breakout, but this is not always necessary. In theFOREX, you are watching the volume of lots traded. This is seenon most software and charting tools, including eSignal.Pullback. Following the breakdown or breakout, the currency pairusually will rebound back up to previous support or resistance.On a breakdown, what was the lower trendline support turns intoresistance, and vice versa. In symmetrical triangles, the pullbackoccurs with more than 21 percent of the breaks, with 16 percentfalling back into the symmetrical triangle formation as a falsemove, and sometimes will change direction totally. You can usethe apex of the trendlines as a stop-loss price.
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FIGURE 6-5 Symmetrical Triangle
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Target. Once the breakout has occurred, the price projection is foundby measuring the widest distance of the pattern at the first confirmation point and adding it to the breakout price.
ASCENDING TRIANGLE: A BULLISH CONTINUATION PATTERNThe ascending triangle is a bullish formation that usually forms during anuptrend as a continuation pattern. Sometimes an ascending triangle formsas a reversal pattern at the end of a downtrend, but typically it is a bullishcontinuation pattern. Regardless of where ascending triangles form, theyare bullish patterns that indicate that buyers are accumulating the currencypair, and it could break out to higher prices in the short term.
RULES OF THE ASCENDING TRIANGLEFigure 6-6 illustrates the rules of the ascending triangle.Trend. Usually it forms in an uptrend.Shape. The top trendline placed across at least two points must makea horizontal line. The highs do not have to be exact but should bewithin reasonable proximity of each other. There should be a fewdays to a few months between the proximal highs. The lowerascending trendline is formed by at least two low points connected by a trendline that angles upward and to the right. Theselows should be successively higher, and there also should be afew days to a few months distance between the lows. There mustbe at least four points touching the trendlines, but there can bemany more than four total.Duration. The length of the pattern can range from a few weeks tomany months, with the average pattern lasting from 1 to 3months.Volume. As the pattern develops, volume usually contracts. When theupside breakout occurs, there is usually stronger volume to confirm the breakout, but this is not always necessary.Throwback. Following the breakout, the currency pair usually will pullback to support. On a breakout, what was the upper trendline resistance turns into support, and vice versa. Sometimes there will be areturn to this support level before the move begins again. This iscalled the throwback. You can use the upper trendline support as atight stop loss and the rising lower trendline as a hard stop.
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FIGURE 6-6 Ascending triangle
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Target. Once the breakout has occurred, the price projection is foundby measuring the widest distance of the pattern at the first confirmation point and adding it to the resistance breakout price.
DESCENDING TRIANGLEThe descending triangle, also a variation of the symmetrical triangle, generally is considered to be bearish and usually is found in downtrends. Theascending triangle is a bullish formation that usually forms during anuptrend as a continuation pattern. Sometimes descending triangles form asreversal patterns at the end of a downtrend, but typically they are bullishcontinuation patterns. Regardless of where they form, descending trianglesare bullish patterns that indicate that buyers are accumulating the currencypair and that it could break out to higher prices in the short term.
RULES OF THE DESCENDING TRIANGLEFigure 6-7 illustrates the rules of the descending triangle.Trend. Usually it forms in a downtrend.Shape. The bottom trendline placed across at least two points mustmake a horizontal line. The highs do not have to be exact butshould be within reasonable proximity of each other. Thereshould be a few days to a few months between the proximal lows.The upper descending trendline is formed by at least two lowpoints connected by a trendline that angles downward and to theright. These highs should be successively lower, and there alsoshould be a few days to a few months’ distance between the lows.There must be at least four points touching the trendlines, butthere can be many more than four total.Duration. The length of the pattern can range from a few weeks tomany months, with the average pattern lasting from 1 to 3months.Volume. As the pattern develops, volume usually contracts. When thedownside breakout occurs, there is usually stronger volume toconfirm the breakout, but this is not always necessary.Pullback. Following the breakdown, the currency pair usually willrebound back up to previous support. On a breakdown, whatwas the lower trendline support turns into resistance, and viceversa. Sometimes there will be a return to this resistance level
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FIGURE 6-7 Descending triangle
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before the down move resumes. This is called the pullback. Indescending triangles, the pullback occurs with more than 23percent of the breakdowns, with 12 percent falling back into thedescending triangle formation and moving upward. You can usethe lower trendline resistance as a tight cover point if you areshort or the falling upper trendline as a hard stop.Target. Once the breakout has occurred, the price projection is foundby measuring the widest distance of the pattern at the first confirmation point and adding it to the resistance breakdown price.
THE FALLING BROADENING FORMATIONThe falling broadening formation is similar to a megaphone in appearance,in that it has diverging trendlines that spread apart from an apex. These aregenerally distinguished by a noticeable slant to the downside.A falling broadening formation generally is considered bearish andusually is found in short-term downtrends or at the midpoint of an uptrend.The implication, however, is still generally bearish. This pattern is markedby a series of lower tops and lower bottoms.The currency typically will bounce off the lower trendline and retracefrom the upper trendline. Once the currency pair breaks out above theupper trendline, the pattern can be considered a reversal, and the uptrendshould resume.
SUPPORT BREAKDOWN OR RESISTANCE BREAKOUTUnderstanding support and resistance is a very important part of chartingto save losses, hold on for gains, and preserve capital. Support refers to theprice level at which a security tends to stop falling because there is moredemand than supply. Technical analysts identify support levels as prices atwhich a particular currency pair has bottomed in the past.When a currency pair is falling toward its support level, it is said to be“testing its support,” meaning that the currency pair should rebound assoon as it hits the support price. If the currency pair continues to dropthrough the support level, its outlook is considered very bearish. When support is broken, it often defines a new resistance point.A support breakdown refers to a currency pair’s previous level of support. Once this level is broken, the currency pair typically will fall to its
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next support level. Technical tools used to determine support levels such astrendlines and the Fibonacci fan frequently will forewarn or suggest that amajor downtrend or consolidation period is ahead.Resistance refers to the price ceiling at which currency pairs reach persistent selling. It is significant when a currency pair breaks through theresistance level because this means that it usually will go on to new highs.When resistance is broken, it often defines a new support level.A breakout refers to a currency pair emerging up through a previousresistance level and usually to a new high. It is significant when the currency pair breaks through the resistance level, in that the volume is increasing because this means it usually will go on to new highs.When resistance is broken, it often defines a new support level. If thevolume is weaker than normal on the breakout, the move higher usuallywill be short-lived due to a lack of broad participation.
THE DOUBLE BOTTOMThe double bottom is a formation in which a currency pair hits a low, rallies,and then falls back to the low. Usually this is a bullish formation that precedes an up move and is an important formation when identifying an entrypoint. The shape of the pattern is much like the letter W in that the currencypair will make two important lows within near price proximity of each other.If the price breaks below the two low points, the pattern is void, and thecurrency pair could continue lower.Typically, the currency pair will move higher off the second low andcontinue to break out above the left arm of the W. At this point the breakoutand the formation are complete, and the currency pair should continuehigher to a target at least equal to that of the height of the formation.
RULES OF THE DOUBLE BOTTOMFigure 6-8 illustrates the rules of the double bottom.Trend. Found both in uptrends and downtrends but more prevalent indowntrends.Shape. Much like that of the letter W, and the formation is completedwhen the price goes above the left arm of the W. There must betwo low points in close price proximity of each other.Duration. The length of the pattern can range from a few minutes tomany.
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FIGURE 6-8 Double Bottom Support
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Volume. As the pattern develops, volume usually contracts. When thebreakout occurs, there is usually stronger volume to confirm thebreakout, but this is not always necessary.Target. Once the breakout has occurred, the price projection is foundby measuring the height of the pattern and adding it to the breakout price.
HEAD AND SHOULDERS (CROWN)A head and shoulders is a formation that usually precedes a sell-off. Thehead and shoulders pattern generally is regarded as a reversal pattern and isseen most often in uptrends. It is also most reliable when found in anuptrend (see Figure 6-9).A rebound that is strong will begin to slow down eventually. About thesame time, supply and demand are generally in balance. Sellers come in atthe highs (left shoulder), and the downside begins (beginning neckline).Buyers soon return to the currency pair and ultimately push through tonew highs. However, the new highs are quickly turned back, and the downside is tested again (continuing neckline).Reduced buying reemerges, and the currency pair rallies once more butfails to take out the existing top level. (This last top is considered the rightshoulder.)Buying dries up, and the currency pair tests the downside yet again.Your trend line for this pattern should be drawn from the beginning neckline to the continuing neckline. In this case, the neckline is descending,which is even more negative.Volume has a greater importance in the head and shoulders pattern incomparison with other patterns and generally decreases as the pattern isbuilt. Once the neckline is broken, the currency pair frequently will sell offan equal distance from the neckline to the head.In this case it could reach 1700. The pattern is completed when themarket breaks the neckline, as we saw in the figure. (Volume shouldincrease on the breakout.)Are you watching out for reversal bars? You should be. The next timeyou see a currency pair down in the morning and then reverse to end up orunchanged on the day, don’t blow it off as a nonevent. Take a closer look.Reversal bars come in two different forms. One version is a churningbar, in which a currency pair’s opening price and closing price are close toor equal to the same price.
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FIGURE 6-9 Head and Shoulders
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There can be a wide price range during the day, but it ends up closingnear where it opened. These days frequently go unnoticed by a novice. Following a big move or if the volume is anything but light, take a close look.The second version is a key reversal, which again follows a short-termtrend in a currency pair. Then a day presents itself when the market movesbig in the same direction in the morning but then reverses to close wellbelow the currency pair’s previous close in an uptrend or well above thecurrency pair’s previous close in a downtrend.The psychology behind this kind of bar is that buyers and sellers arepouring into the particular currency pair with equal enthusiasm and essentially run out of steam. If the currency pair is in an uptrend, the buyers runout of new money or buying power, so the currency pair will then fallbringing pressure to the sellers that are out there, and the currency pair canretrace without any real selling pressure.The same happens in a downtrend. If the currency pair has been sellingoff recently and you see a churning bar on high volume, this could be a bottom. The buyers are coming in and soaking up all the sellers. Therefore, thebuyers in the future can move the currency pair higher without much overhead selling pressure. The currency pair can then move higher until the“churning buyers” get enough profits to start selling themselves.There are many different strategies with which you can trade. I only covered a few simple rules that many professional traders follow. Most professional traders take these same techniques and refine them to their very owntrading styles. As we are all different, in our lives and financial needs,we haveto tailor our investing to our own specific needs. You can learn how to tradefollowing some of the guide lines we just discussed or you can create yourown. You could even use