Generating Signals from RSI

RSI signals that are not derived from overbought or oversold

Ever wondered how you can generate signals from RSI apart from the usual overbought and oversold levels? It can be done although personally I wouldn't trade on signals that do not include an input from price. Let's face it RSI can be very frustrating when it fails to reach overbought or oversold for long periods of time. Well, let's just consider what RSI is telling us and whether we can use that concept in another way.

In fact RSI is calculated by measuring the sum of the higher closes and also the sum of the lower closes and normalizing the ratio of the result within a band of zero to 100. Clearly, when price rises then the sum of the positive close movement is larger than that of the negative close movement and thus RSI moves higher. The opposite is also obviously true.

Therefore RSI is reacting to sustained directional moves in one direction. What we need try and obtain from that information is when the RSI moves sufficiently in one direction is there risk of follow-through. We actually do this type of thing with price by placing Bollinger Bands around price and looking for breaks of the upper or lower bands. It is possible to do just that with RSI. It will look like this:

The bands are based on a 9 period average with a standard deviation of +/- 1. The idea I am investigating is whether breaks of either band by the RSI constitutes a valid signal. However, without even looking at price I can see that the number of occurrences where the band is broken but does not sustain a movement in that direction is quite frequent.

One of the most important factors, in my opinion, when trading is to match a signal generated by a technical indicator with price. Too often the movement in price that generates a break in an indicator fails to follow through. Because of that I like buying breaks of resistance or selling breaks of support. Therefore I can include both conditions in my trading.

In this way, when RSI breaks above the Bollinger high then I will only trade if price also breaks above resistance. What I tend to look at are swing bars - that is where a peak is formed and has at least 1 or 2 lower highs surrounding it (and vice verse for a trough.) So when RSI breaks above the upper band I will want to buy at the level of the swing high. If RSI breaks below the lower band I will want to sell at the level of the swing low.

The following shows how this may look:

Let's look at what we can generate from these combined signals one by one. I have marked swing highs and lows with a small red horizontal line:

1. RSI dips below the lower Bollinger Lower Band. However, by the time it has confirmed this (at the close of the bar) price has already dipped below the swing low - it is too late to trade.
2. RSI breaks above the Bollinger Higher Band. However, price fails to follow through above the swing high. No trade is seen.
3. RSI breaks above the Bollinger Higher Band and on the next bar price confirms this move by penetrating the swing high. We buy at the swing high level. Price continues higher and then pulls back. In order to provide a trailing stop I have also entered a fairly fast SAR/Parabolic and we square on the 9th bar of the trade at the Parabolic level for a modest profit.
4. RSI breaks below the Bollinger Lower Band. However, price does not break below the swing low. No trade.
5. RSI once again breaks below the Bollinger Lower Band. However, price does not break below the swing low. No trade.
6. RSI breaks above the Bollinger Higher Band and on the next bar price confirms this move by penetrating the swing high. We buy at the swing high level. Price continues to rally and to the right of the chart the position is still open having remains above the Parabolic.

Quite clearly the benefit of combining a signal from an indicator and from price appears to be working well, filtering out the bad indicator signals.

It is quite easy to have Bollinger Bands plotted on the RSI by writing a new indicator in the Chart Studio using CTL. To do this open up your Chart Studio and then in the system modules (click on the tab at the bottom left of the screen) and then scroll down to find “Relative Strength” and double click on it. This will open the coding for the RSI which is shown below. You will need to make some minor changes or just copy and paste the following into a new page:

indicator RSIandBollingerBands;
input price = close, period = 14, SD = 1, BollPeriod = 9 ;
draw line("RSI"), BBhigh("Bollhigh"), BBlow("BollLow");
vars i(number), u(series), d(series), au(series), ad(series), dif(number), f(number),RS(series);
begin
f := front(price);
u[f] := 0;
d[f] := 0;
for i := f + 1 to back(price) do begin
dif := price[i] - price[i - 1];
if dif > 0 then begin
u[i] := dif;
d[i] := 0;
end else begin
u[i] := 0;
d[i] := -dif;
end;
end;
au := mma(u, period);
ad := mma(d, period);
RS := 100 * au / (au + ad);
line := RS ;
BBhigh := SMA(RS,7) + SD * stddev(RS, Bollperiod) ;
BBlow := SMA(RS,7) - SD * stddev(RS, Bollperiod) ;
end.

• From the menu bar select “Build” and then “Verify Module.”
• You will be prompted to save the file. Name this “RSI and Bollinger Bands”
• Against select “Build” and then “Verify Module.”
• Finally once again select “Build” but this time “Install Module.”

You should find that the indicator appears in the “User Modules” window at the left of the screen. When you go back to your charting area and insert an indicator you will find “RSI and Bollinger Bands” will be available to insert into the chart.

Using Fibonacci Levels to Detect Range Bound and Trending Markets

Why we shouldn't buy breakouts

The FX-market oscillates on a regular basis between range bound and trending markets. In range bound market conditions, traders typically adopt a simple buy low, sell high approach, where as trending market climates call for traders to trade with the trend. However detecting whether the market is currently in a range bound or trending environment can be tricky, and costly if applied inaccurately. With that said, the Fibonacci levels can provide a valuable insight to the current market climate and the appropriate trading approach.

The first chart below shows a significant rally to the upside, as the trend reversed direction, the market then passed through all 3-commonly used Fibonacci levels; 38.2%, 50%, & 61.8%. Due to the fact that not one of our Fibonacci levels established our new support, we can extrapolate that a trend is not probable. It is important to keep in mind that trends exist when there is an uneven distribution of buyers and sellers, forcing the market to new high/low prices. However due to the fact that the market fell back below every Fibonacci line, indicates that the buyers were not in fact in control of the marketplace. Finally note how the market then accomplished a 'slightly' new low before reversing once again back to the upside. If we were to sell short the market at its slightly new low price, we would have certainly exited the trade at a loss.

We may now see how the market rallied back to the upside, and found a new (lower) resistance at the 50% Fibonacci level; measured now from our recent high to low prices. Due to the fact the market's progress was then halted at a specific Fibonacci level tells us that at that moment in time, the sellers had in fact gained control of the marketplace as they will not allow the buyers to force us back to recent highs, and an ensuing downtrend is now more probable.

These observations also teach us a valuable lesson against the practice of buying new highs or selling new lows. Conventional wisdom dictates that if the market accomplishes a new high price, the short (stops) will be triggered, in turn will compel the market to even higher highs. However upon careful study of the two aforementioned charts, we learn that if a new trend is intact, the market 'should have' found a new support/resistance level at one of the previous Fibonacci lines. After the first rally to the upside was complete, and as the market retreated back to recent lows, the fact that the market did not find a new (higher) support at one of our Fibonacci levels tells us that the buyers were not in fact, in control, and a relatively equal distribution of power remained between the buying and selling forces which have a greater chance of keeping us in a perpetual range bound market environment. On the other hand, due to the fact that the market found new lower resistance at a Fibonacci level indicates stronger selling pressure, and a greater likelihood of a new trend to the downside will now emerge.

Enhancing Currency Trading with the Elliott Wave Analysis

One of the most common topics of conversation for traders is Elliott Wave analysis. Ironically, few traders actually apply this method because many are unsure about the intricacies of the Elliott Wave. In truth, correct analysis and counting of the waves can be a daunting task. However, even without the help of electronic wave analysis, traders should be able to enhance their profitability with a disciplined use of Elliott's method.

How It All Started

In the first half of the 20th century, Ralph Nelson Elliott concluded that financial markets have a striking resemblance to a basic harmony found in nature and postulated that price movements in financial markets follow patterns but not necessarily in time or amplitude. Elliott set up the Wave Principle on empirically derived rules for interpreting the price action.

Basics of Wave Analysis

Elliott postulated that financial prices unfold according to a basic rhythm or pattern: five waves in the direction of the trend and three waves counter trend. He named the five-wave upward movement an impulse wave, and the three-wave counter trend- a corrective wave.

Within the five-wave bull move, waves 1, 3 and 5 are called impulse waves. They are subdivided into five waves of smaller scale. The subwaves of impulse sequences are labeled with numbers. Waves 2 and 4 are corrective waves, subdividing into three smaller waves each. The subwaves of corrections are labeled with letters.

Waves of any degree in any series can be subdivided and then subdivided again into waves of a smaller degree, as follows:

IMPULSE CORRECTIVE CYCLE
Waves 1 1 2
First subdivisions 5 3 8
Second subdivisions
Subdivisions 21 13 34
Third subdivisions
Subdivisions 89 55 144

Elliott's Rules of Interpretation

Elliott identified three essential rules of interpretation of his wave principle:

Wave 2 may never retrace more than 100% of wave 1.
Wave 3 is never the shortest; most of the time the longest.
Wave 4 can never enter the price range of wave 1.

Characteristics of the Waves:

• Wave 1.
  Wave 1 is difficult to identify because it appears to be more of a correction. It is often the shortest of the impulse waves.
• Wave 2.
  Wave 2 should be easier to identify due to its three-subwave structure. It tends to retrace by about .618% of the first wave.
• Wave 3.
  Wave 3 is usually the longest and it is never the shortest. It has a dynamic move, and the penetration of the top of Wave 1 attracts more demand in a bull market. Naturally, this makes for a good volume and fundamentals support the move.
• Wave 4.
  According to the rule of alternation, if wave 2 is complex, then wave 4 tends to have a less complex pattern and vice versa. Of course, Wave 4 can never enter the price range of Wave 1.
• Wave 5.
  Wave 5 can be dynamic and extended, as Figure 8 shows. By now everyone has figured out the long-term trend and these conditions can create a good overshooting scenario.
• Wave A.
  Wave A is difficult to catch through all the euphoria. A good hint comes from the break into five subwaves.
• Wave B.
  Wave B may be of different complexities and lengths since the last bulls are making their final mark in a previously rising market and the bears are testing the waters and starting to go short.
• Wave C.
  Wave C puts the stamp on the end of the trend. Following a bull market, wave C should fall below the bottom of wave A.

Impulse Waves - Variations

Elliott Wave identifies several extensions, which are not easy to use. In the five-wave sequence, one of the three impulse subwaves tends to generate an extension. These subdivisions are of nearly the same amplitude and duration as the larger-degree waves of the main impulse sequence, giving a total count of nine waves of similar size rather than the normal count of five for the main sequence.

Extensions can be useful guides to the lengths of future waves. Most impulse sequences contain extensions in only one of their three impulsive subwaves. Therefore, if the first and third waves have about the same magnitude, the fifth wave will probably be extended. Extensions may also occur within extensions. Although extended fifth waves are not uncommon, extensions of extensions occur most often within third waves.

FAILURES OR TRUNCATED FIFTHS

Elliott called failure any impulse pattern in which the extreme of the fifth wave fails to exceed the extreme of the third wave.

Corrective Waves

Market swings tend to move easier with the trend of a larger degree than against it. Therefore, corrective waves can be highly complex, choppy and often difficult to interpret before completion.

The most important characteristic about corrections is that they never consist of five subwaves. Only impulse waves consist of five subwaves.

Elliott identified the following four corrective patterns:
1. Zigzags (5-3-5)
2. Flats (3-3-5)
3. Triangles (3-3-3-3-3)
4. Combined structures

Zigzags are simple three-wave patterns, subdivided into 5-3-5 structures, in which the extreme of wave B remains a significant distance from the beginning of wave A. Occasionally, a double zigzag formation may occur.

FLATS - Flat corrections have a 3-3-5 structures. The original movement of wave A lacks the momentum to develop into a full five waves, as in a zigzag. Wave B also lacks countertrend pressure and often ends at or beyond the start of wave A. Wave C usually finishes near the extreme of wave A, rather than significantly beyond it, as in a zigzag. Elliott identified four types of flats: regular, expanded, irregular and running.

TRIANGLES - Triangles tend to occur just before the final rally in the direction of the trend. They tend to be extended because of low volume and low volatility during a consolidation period. Triangles consist of five waves, labeled A-B-C-D-E, subdivided into three waves each. The four types of triangles are symmetrical, ascending, descending and expanding. After completion of a triangle, the final impulse wave of the larger trend is usually swift and has a price objective equal to the base of the triangle. This movement is called a thrust.

COMBINED STRUCTURES - In Elliott Wave analysis, zigzags and flats are often called threes. These combined structures consist of two or more threes separated by smaller three-wave movements, labeled X waves. For example, a double three may consist of a flat, a smaller zigzag-forming wave X and a second flat, or it might contain a zigzag , a smaller flat in wave X and a second zigzag. The combined structures are generally sideways formations reflecting market hesitation.

Conclusion

A disciplined analysis and a trained eye should help you get a good grip on Elliott's method. While it can be complex and time consuming, it is also an excellent approach to true forecasting.

Enhancing Currency Trading with the Elliott Wave Analysis

One of the most common topics of conversation for traders is Elliott Wave analysis. Ironically, few traders actually apply this method because many are unsure about the intricacies of the Elliott Wave. In truth, correct analysis and counting of the waves can be a daunting task. However, even without the help of electronic wave analysis, traders should be able to enhance their profitability with a disciplined use of Elliott's method.

How It All Started

In the first half of the 20th century, Ralph Nelson Elliott concluded that financial markets have a striking resemblance to a basic harmony found in nature and postulated that price movements in financial markets follow patterns but not necessarily in time or amplitude. Elliott set up the Wave Principle on empirically derived rules for interpreting the price action.

Basics of Wave Analysis

Elliott postulated that financial prices unfold according to a basic rhythm or pattern: five waves in the direction of the trend and three waves counter trend. He named the five-wave upward movement an impulse wave, and the three-wave counter trend- a corrective wave.

Within the five-wave bull move, waves 1, 3 and 5 are called impulse waves. They are subdivided into five waves of smaller scale. The subwaves of impulse sequences are labeled with numbers. Waves 2 and 4 are corrective waves, subdividing into three smaller waves each. The subwaves of corrections are labeled with letters.

Waves of any degree in any series can be subdivided and then subdivided again into waves of a smaller degree, as follows:

IMPULSE CORRECTIVE CYCLE
Waves 1 1 2
First subdivisions 5 3 8
Second subdivisions
Subdivisions 21 13 34
Third subdivisions
Subdivisions 89 55 144

Elliott's Rules of Interpretation

Elliott identified three essential rules of interpretation of his wave principle:

Wave 2 may never retrace more than 100% of wave 1.
Wave 3 is never the shortest; most of the time the longest.
Wave 4 can never enter the price range of wave 1.

Characteristics of the Waves:

• Wave 1.
  Wave 1 is difficult to identify because it appears to be more of a correction. It is often the shortest of the impulse waves.
• Wave 2.
  Wave 2 should be easier to identify due to its three-subwave structure. It tends to retrace by about .618% of the first wave.
• Wave 3.
  Wave 3 is usually the longest and it is never the shortest. It has a dynamic move, and the penetration of the top of Wave 1 attracts more demand in a bull market. Naturally, this makes for a good volume and fundamentals support the move.
• Wave 4.
  According to the rule of alternation, if wave 2 is complex, then wave 4 tends to have a less complex pattern and vice versa. Of course, Wave 4 can never enter the price range of Wave 1.
• Wave 5.
  Wave 5 can be dynamic and extended, as Figure 8 shows. By now everyone has figured out the long-term trend and these conditions can create a good overshooting scenario.
• Wave A.
  Wave A is difficult to catch through all the euphoria. A good hint comes from the break into five subwaves.
• Wave B.
  Wave B may be of different complexities and lengths since the last bulls are making their final mark in a previously rising market and the bears are testing the waters and starting to go short.
• Wave C.
  Wave C puts the stamp on the end of the trend. Following a bull market, wave C should fall below the bottom of wave A.

Impulse Waves - Variations

Elliott Wave identifies several extensions, which are not easy to use. In the five-wave sequence, one of the three impulse subwaves tends to generate an extension. These subdivisions are of nearly the same amplitude and duration as the larger-degree waves of the main impulse sequence, giving a total count of nine waves of similar size rather than the normal count of five for the main sequence.

Extensions can be useful guides to the lengths of future waves. Most impulse sequences contain extensions in only one of their three impulsive subwaves. Therefore, if the first and third waves have about the same magnitude, the fifth wave will probably be extended. Extensions may also occur within extensions. Although extended fifth waves are not uncommon, extensions of extensions occur most often within third waves.

FAILURES OR TRUNCATED FIFTHS

Elliott called failure any impulse pattern in which the extreme of the fifth wave fails to exceed the extreme of the third wave.

Corrective Waves

Market swings tend to move easier with the trend of a larger degree than against it. Therefore, corrective waves can be highly complex, choppy and often difficult to interpret before completion.

The most important characteristic about corrections is that they never consist of five subwaves. Only impulse waves consist of five subwaves.

Elliott identified the following four corrective patterns:
1. Zigzags (5-3-5)
2. Flats (3-3-5)
3. Triangles (3-3-3-3-3)
4. Combined structures

Zigzags are simple three-wave patterns, subdivided into 5-3-5 structures, in which the extreme of wave B remains a significant distance from the beginning of wave A. Occasionally, a double zigzag formation may occur.

FLATS - Flat corrections have a 3-3-5 structures. The original movement of wave A lacks the momentum to develop into a full five waves, as in a zigzag. Wave B also lacks countertrend pressure and often ends at or beyond the start of wave A. Wave C usually finishes near the extreme of wave A, rather than significantly beyond it, as in a zigzag. Elliott identified four types of flats: regular, expanded, irregular and running.

TRIANGLES - Triangles tend to occur just before the final rally in the direction of the trend. They tend to be extended because of low volume and low volatility during a consolidation period. Triangles consist of five waves, labeled A-B-C-D-E, subdivided into three waves each. The four types of triangles are symmetrical, ascending, descending and expanding. After completion of a triangle, the final impulse wave of the larger trend is usually swift and has a price objective equal to the base of the triangle. This movement is called a thrust.

COMBINED STRUCTURES - In Elliott Wave analysis, zigzags and flats are often called threes. These combined structures consist of two or more threes separated by smaller three-wave movements, labeled X waves. For example, a double three may consist of a flat, a smaller zigzag-forming wave X and a second flat, or it might contain a zigzag , a smaller flat in wave X and a second zigzag. The combined structures are generally sideways formations reflecting market hesitation.

Conclusion

A disciplined analysis and a trained eye should help you get a good grip on Elliott's method. While it can be complex and time consuming, it is also an excellent approach to true forecasting.

Dual Moving Averages ... the Market's Favorite…

Why moving averages are my least favored trading tool

"What moving averages do you use?"

Isn't that a common question? Is there and answer? Of course, many traders use moving averages. Which are the best periods to use then?

My answer: "Depends on how much money you want to lose."

I am fascinated by the market's fascination with moving averages. Why? Am I missing something? I have seen all sorts of strategies using moving averages but have never seen a strategy that is stable and makes steady profit with a low drawdown.

Let's take a look at a simple dual moving average strategy that simply buys when they cross higher and sells when they cross lower. I used this on a chart of the Euro against the Dollar and to begin with I have limited this to a period of five years from the introduction of the Euro in January 1999.

Just to speed up the process I optimized the two periods which ended up as 9 periods for the short moving average and 35 for the long moving average.

Capital	$20,000	Leverage 5x	EUR 80,000
Total Net Profit	0.4918	Gross Profit	0.8088
		Gross Loss	(0.3170)
Total # of trades	38	Percent profitable	55.26%
Number winning trades	21	Number losing trades	17
Max intraday drawdown	(0.0908)	As a % of capital	(36.32%)
Largest winning trade	0.1046	Largest losing trade	(0.0442)
Average winning trade	0.0385	Average losing trade	(0.0186)
Ratio avg win/avg loss	2.0654

1999	0.0983	39.32%
2000	0.1355	54.20%
2001	0.0396	15.84%
2002	0.0759	30.36%
2003	0.1425	57.00%
TOTAL	0.4918	196.72%

Let's look at these numbers.

First of all I took an average rate of 1.25 for the EURUSD rate and came to a position size on a 5x leverage of EUR 80,000. This is probably a bit high, but for the sake of examining just how good a strategy is it will suffice.

Well, we have see 55.26% of the trades make profit and the ratio of profit to loss is over 2:1. That is quite good. The total net profit over the 5 years is 0.4918 – so very nearly 0.1000 per annum. Looking at the results for each year we see the lowest return was 15.84% (2001) and the highest was 57.00% (2003). I'd be happy with that. We've almost trebled our capital in that time although we would have had to have gone through something like a 36.32% drawdown in capital at some point.

These numbers are good!

So on the 1st January 2004 we can start trading… and these would have been the results since then:

Capital	$20,000	Leverage 5x	EUR 80,000
Total Net Profit	(0.0922)	Gross Profit	0.2704
		Gross Loss	(0.3626)
Total # of trades	27	Percent profitable	22.22%
Number winning trades	6	Number losing trades	21
Max intraday drawdown	(0.1480)	As a % of capital	(59.20%)
Largest winning trade	0.0889	Largest losing trade	(0.0379)
Average winning trade	0.0451	Average losing trade	(0.0173)
Ratio avg win/avg loss	2.6100

2004	(0.0073)	(2.92%)
2005	(0.0416)	(16.64%)
2006	(0.0128)	(5.12%)
2007	(0.0130)	(5.20%)
TOTAL	(0.0747)	(29.88%)

Suddenly the numbers don't look quite so good… Every year has recorded a loss and the maximum drawdown was almost 60% of capital. Only 6 out of the 27 trades made profit over the 3.25 years.

Was there something wrong with the optimization? How could the same moving average periods lose so much money?

I have news… this is very, very common.

The next question is normally "Can I add a money management stop, trailing stop or take profit."

Of course you can but do remember there are two risks involved. To be honest a money management stop should always be employed. However, there can be a downside in that when set to a level with which you feel comfortable it can actually increase the drawdown. What can happen especially with simple moving average systems is that since they provide a lagging entry signal, the subsequent pullback is so deep it will catch the money management stop. This often takes a loss on a position you may have profited from without the stop and if there are too many of these it can actually cause the drawdown much higher.

Trailing Stops and Take Profit Stops are also valid methods to take more control over positions. Here however you will need to avoid optimizing them. If anything they should be set to a non-fixed amounts but reflect market volatility through using volatility. Optimizing these is not recommended. The more variables you put into your system the more unstable it becomes.

The final question is then usually asked. "Is there any way to more thoroughly check whether the optimization has provided a stable result?"

The answer is most definitely yes. Look at the profit results of all the optimized periods. For example, let's look at the strategy above. After optimization the moving average periods used were 9 and 35. Each of these should be examined to observe how stable the results are around the optimum period. Look at the following graphs of results:

On the left are the results of all lengths in the short moving average period from 5 to 12 while on the right are the results of all lengths in the long moving average period from 30 to 40.

Note on the left that around the optimum 9 period average the next best results are around 1,000 points lower and going out to the extremes these move down to 2,000 points lower. Equally, on the right we see a similar result.

It must be understood that when optimizing the chances of seeing profits as high as suggested by the optimum periods are very, very low and thus do not even begin to think that your trading results will be any where close. The best type of result you should be looking for in a type of flat bell curve which sees limited reductions in profit either side of the optimum. Even then, the more variable parameters you utilize the more chance there is of these causing an exponential reduction in profitability in your strategy.

What I have pointed out here with two moving averages is common of a poor strategy but very common using moving averages. They are really not good trading tools.

Moving Averages as a Forecasting Indicator

There is reason for caution when analysts tell you that moving averages forecast price movement

Many analysts still claim that moving averages can be used to forecast the subsequent day's movement. I'm not sure why this is considered true as none of the tests I have ever done suggest that they are anything less than poor at the role. In fact, almost certainly they would lose money when used in this fashion.

Let me go through a test to highlight the numbers and the risk of loss.

The first test is a simple trading strategy. If the moving average closes higher then the strategy will buy at the next day's opening price and exit at close. In fact, just to try and discover the best parameter for Dollar-Yen I optimized the period used on a daily chart over 5 years from 2002 to 2006 and fount the very best period was a 7 day exponential moving average. The results can be summarized as follows:

Year Profit (in points)
2002: 1,299
2003: (664)
2004: 1,775
2005: (224)
2006: (840)

Total: 2,568

Maximum drawdown: 1,343 points (maximum loss from the equity high point)
% of winning trades: 50.89%
Average Profit: 50 points
Average Loss: 48 points
Ratio of profit/loss: 1 : 1.04

Let's just look at the numbers. First of all the net total over 5 years represents about 500 points a year. If we use a conservative 5x leverage it will represent an approximate 22.5% return a year on average. Not too shabby.

Now let's look at the maximum drawdown, a massive 1,343 points which using the same leverage would have lost you 61% of your capital and would have severely restricted your ability to trade at the same leverage, not even to mention whether you would have just plain given up.

Let's look at something more damning. By necessity chart prices are constructed using the bid price only and thus you should always look at allowing for the 3 point spread. Let me add in a 3 point slippage. The figures now look like this:

Year Profit (in points)
2002: 537
2003: (1,435)
2004: 992
2005: (553)
2006: (840)

Total: (1,299)

Maximum drawdown: 2,181 points (maximum loss from the equity high point)
% of winning trades: 48.25%
Average Profit: 50 points
Average Loss: 48 points
Ratio of profit/loss: 1 : 1.03

Clearly in reality we would have probably made a loss just because of the bid/offer spread! What is more, the maximum drawdown of 2,181 points would have implied a loss of 99% of our capital!

I think that clearly shows that moving averages simply do not forecast the next day's movements. However, in addition to the above the results shown are from using the optimized period. In reality we wouldn't know the optimum period until after the fact and would have to hope that the period chosen would continue to make the same level of profits. I have met many traders who think this is a reasonable assumption.

Well, to dispel any such ideas let me show you the graph of the profit/loss across the range of optimization periods which I organized from 3 to 30:

Out of 28 periods used only 9 actually produced profit. The 7 period average made the most at 2,568 points (before allowing for the spread) while the next best profit was the 6 period average which only made 1,620 points. When allowing for the spread no period of moving average made any profit at all.

I hope this puts to rest the claim that moving averages can be used to forecast price.

Using Support and Resistance Levels

A guide to determining approximate reversal levels

Support and resistance is a tool which is often used but quite often the source of the support and resistance levels are not often completely obvious. There are several ways to derive these levels:

1. Previous support remains supportive until broken and vice versa
2. Previous support becomes resistance and vice versa in pivot levels
3. Fibonacci derived support and resistance either by retracement or projections

The third method is the most accurate but the process of learning how to calculate these using the right levels requires a large degree of experience and skill using Elliott Wave. I shall therefore concentrate on the first two in this article.

In the image above the upper chart is of daily Dollar-Yen while the lower is the weekly chart.

Now the first thing to remember is that trends are developed when (in an uptrend) highs are moving higher and lows are moving higher. In a downtrend the lows are moving lower while the highs are also moving lower.

Thus when in an uptrend the most recent low is broken we need to decide where price might finally make a corrective low.

For example, we can see in the daily chart that price rallies to the 121.38 high at point (1). It then reverses, breaking below previous lows in the uptrend. So now we know the uptrend is reversed but where will the decline reach?

In the weekly chart we can see two prior lows around 115.50 which also provided resistance in an earlier correction. It is this pivot area where the first decline to point (a) completes. The correction to point (b) can often be measured by Fibonacci retracements and in the case it was 76.4%.

The next decline in the daily chart to point (2) reaches 108.96. This is just 26 points above the last major low at 108.70 before the rally to 121.38. It is very frequent that the first retracement will move to the most recent major low (after a rally) or the most recent high (in a decline). A horizontal line has been marked on the weekly chart to show this support area.

Now that we have identified the approximate area of the low and we see a recovery we can begin to look at where this may reach. We should remember the pivot area around 115.50 although while it did see a reaction for a few days price quickly broke through and we then need to look for the next resistance.

Here is a little tip that can be useful. Where you see a very distinctive 3-leg move as we did from the 121.38 high down to 108.96, the retracement will quite often move to the extreme of the middle correction - in this case at point (b). The high was at 119.38 and the rally to Point (c) ended at 119.87 - just 50 points above.

From the 119.87 peak we can see how price then declined and penetrated the series of supporting lows so we then look at the 115.50 pivot area again but since this didn't hold too well on the way up we can begin to look at the series of lows that spread across from the 113.41 low at Point (a) and the last major low which was at 113.95. We should expect the correction lower to find a correction close to the 113.41-95 area. In the end the correction ended at 114.42 at Point (3).

The next rally then moves up to retest and break the 121.38 high at Point (4). We may have been tempted to call price higher then but the break below the corrective lows signaled a reversal lower which has been declining back towards the 113.41-114.41 lows and still may just get there.

Of course, using support and resistance areas in this way is an approximation and it should not be expected to find accurate or final support or resistance levels but can be useful in determining the basic direction. Certainly as price approaches these levels you should always be looking at the lower time-frame chart to spot reversal patterns or breaks of short time-frame trend lines and also of the most recent lows/highs that would indicate a reversal.

Percent R ... Just What is it?

A deeper look at Percent R

Have you ever scanned through the list of indicators to see whether there is anything interesting that you think you can use? Did you input Percent R? Maybe you thought it was useful, perhaps not. Did it remind you of anything? It looks similar to Fast Stochastics possibly…

Just for a look I have inserted both Fast Stochastics (above in blue) and Percent R (below in red). They do seem to have similarities and certainly a similar reaction in timing but the scaling for Percent R is negative while that of Fast Stochastics is positive.

Actually they are the same.

Let us just look at the formula for each:

Fast K = 100 * ( Close - Lowest Low ) / ( Highest High - Lowest Low )

% R = -100 * ( Highest High - Close ) / ( Highest High - Lowest Low )

Quite clearly they are measuring the same relationship between the position of the close within the range of the chosen number of recent bars. The difference between the two is that Stochastics measures the position of the close from the highest high in the range while %R measures the close from the lowest low in the range.

You will also see from the formula of %R that the result is multiplied by -100 and this results in a scale of zero to -100 while Stochastics has a scale from zero to +100. Then why is there a difference between the two in Dealbook? That is because the default period used in Stochastics is 8 while %R uses 14.

What I did was change the %R calculation to use +100 as the multiplying factor to arrange the results in a scale from zero to 100. I then used a period of 14 for both indicators and then plotted them in the same chart:

Now you can see that the two are in fact identical. Why does %R provide an alternative method of displaying the same information? To be honest I really don’t know why and since they are exactly the same I personally do not use %R and if I want to use this type of momentum indicator I apply Stochastics.

Percent R ... Just What is it?

A deeper look at Percent R

Have you ever scanned through the list of indicators to see whether there is anything interesting that you think you can use? Did you input Percent R? Maybe you thought it was useful, perhaps not. Did it remind you of anything? It looks similar to Fast Stochastics possibly…

Just for a look I have inserted both Fast Stochastics (above in blue) and Percent R (below in red). They do seem to have similarities and certainly a similar reaction in timing but the scaling for Percent R is negative while that of Fast Stochastics is positive.

Actually they are the same.

Let us just look at the formula for each:

Fast K = 100 * ( Close - Lowest Low ) / ( Highest High - Lowest Low )

% R = -100 * ( Highest High - Close ) / ( Highest High - Lowest Low )

Quite clearly they are measuring the same relationship between the position of the close within the range of the chosen number of recent bars. The difference between the two is that Stochastics measures the position of the close from the highest high in the range while %R measures the close from the lowest low in the range.

You will also see from the formula of %R that the result is multiplied by -100 and this results in a scale of zero to -100 while Stochastics has a scale from zero to +100. Then why is there a difference between the two in Dealbook? That is because the default period used in Stochastics is 8 while %R uses 14.

What I did was change the %R calculation to use +100 as the multiplying factor to arrange the results in a scale from zero to 100. I then used a period of 14 for both indicators and then plotted them in the same chart:

Now you can see that the two are in fact identical. Why does %R provide an alternative method of displaying the same information? To be honest I really don’t know why and since they are exactly the same I personally do not use %R and if I want to use this type of momentum indicator I apply Stochastics.

Things to Watch for... MACD

Avoiding the pitfalls of using MACD in your trading

MACD is used quite widely among traders mainly, it would seem, because the basis for the indicator is something they can visualize - effectively measuring the degree of convergence or divergence of two exponential moving averages. Commonly traders will consider buying or selling on crossover of the MACD lines. However, there can be problems and it is worth understanding when these may occur.

Let us take a look at the MACD plot on a weekly chart of USDJPY:

Broadly we would be pleased with the general signals being generated from MACD in this chart. While the crossover of the MACD across the signal line never really occur at market extremes, in this case they are pretty close and one cannot expect a lagging indicator to provide signals at price extremes.

It can be seen that before the moving averages cross the MACD is signaling a reversal earlier and allowing an early entry into a potential trade. Perfect. We can begin to trade on this indicator then… Or can we..?

Take a look at the second chart, still the weekly chart of USDJPY but from a year or two later:

At first it looks quite good. MACD signals a sale into the large decline to the historic 79.70 low and a little later a reversal higher. There is lots of profit to be taken there. However, watch as the MACD peaks out soon after the initial rally from the 79.70 low. The two exponential moving averages continue to point higher and indeed do not cross lower until after the 147.65 peak. However, MACD spends around one year in a decline while price has continued to rally.

This is a recipe for losses.

Why is it that MACD can provide such a bad signal since it is based on two exponential moving averages?

The answer lies in the name: Moving Average Convergence and Divergence.

While the exponential moving averages are rising, the trend has slowed to the point that while only slightly the averages are converging - that is, moving closer together and this has caused the MACD to cross below the signal line.

Well, is there any way to control the trades to make sure that we do not make those trades? Indeed. One of the best tips I can offer is to remember the definition of a trend. An uptrend is where both highs and lows are moving higher. Thus, until the most recent low s broken there is no break/reversal of the trend.

Let us look at how this would have worked:

As can be seen, I have drawn a horizontal line under each successive swing low. At no point is one of these broken until after the final high to the upper right of the chart. Thus, by combining information garnered from the price chart you can avoid many loss making trades.

Head & Shoulders

The EURUSD (1-Hour Chart) has now established what appears to be a classic "Head and Shoulders" pattern over the course of the past few weeks. This pattern is essentially a 'triple top' pattern, where the center top (Head) stands higher than the first or third tops (Shoulders). The rational occurs as the result that the market was not able to revisit recent high prices established during the center top, and therefore is inherently a sign of an imminent reversal to come. Typically, to complete the head and shoulders pattern, we must wait for the market to break below the lows established during this triple top patter; (neckline). However in regards to placing the actual trade, it is in our best interest to sell-short the market as it tests and fails to break above the highs of the 2nd shoulder, while placing protective stops above the highs of the shoulders and perhaps the highs of the center top (head). By doing so, this trade can provide us with a favorable risk to reward scenario if the market does in fact breakdown below our horizontal support line to new low's.

Stochastics Cross Signal

A useful strategy to reduce your losses using stochastics crossover signals

Stochastics are often used to generate buy and sell signals when the %FastD crosses above or below %SlowD. Just how good are these signals?

The stochastic plot here shows where entries are indicated:

I have not circled all the signals but just four in the center of the chart that only shows the stochastic plot. The buy signal occurs when %FastD crosses above %SlowD and the sell signal occurs when the opposite is seen - when the %FastD crosses below %SlowD. However there are two other signals in between that provide first a sell signal and then a buy the next bar. This is rather annoying.

Let us seen how the entries might look on a chart.

Clearly, when there is a modestly sustained move the Stochastic crossovers can provide a reasonable profit but all too often in the small, rather tight range consolidations it can give back much too much of hard earned profits.

Is there any way we can try and prevent this give back? I tend to consider the plain signals provided by momentum indicators as too simple and in a way that doesn't really fully take price development into consideration. Does a reversal of the %FastD through %SlowD constitute a directional reversal? Personally I do not think so.

Then what does represent directional reversals? Well, if you go back to a fundamental premise on what constitutes a trend it can be defined by looking for higher highs and higher lows in an uptrend and vice versa for a downtrend. If we then just trade without looking at the price chart just because %FastD has crossed through %SlowD then we're really not think about what we're doing. Quite often price can see a one or two bar reversal but not to the extent that it penetrates the most recent sequence of higher lows (in an uptrend) or lower highs (in a downtrend.)

What we can do is stipulate that we'll only buy on a Stochastic cross higher if price penetrates the last swing high, or if the Stochastic crossover is lower then on the breach if price penetrates the last swing low:

You can see by doing this it does reduce the number of trades dramatically but actually takes out most of the losing trades. The first short sell to the bottom left of the chart will produce a loss - but this is compared to 6 losing trades without the price filter. The long trend is kept intact in the center of the chart as price rallies and is reversed soon after the peak. We then see two sell signals with no buy signals.

The techniques is not foolproof, as any methodology has its weak points at times, but it can be seen that using a price signal along with a momentum signals can dramatically reduce the number of losses you may need to take on using such a strategy.

Using Multiple Time Frames in Your Analysis II

Utilizing a lower time frame chart to identify when Bollinger support/resistance will hold

Following on from the first description of using multiple time frame charts to both strengthen your analysis and enable tighter entry and exit trades, let us take another look at using these in a different example.

Many traders like to use Bollinger Bands to try and identify entry signals. The problem I have always had with them is that they only provide approximate support and resistance which causes problems in knowing where you should enter and where the stops should be placed. Not only that but sometimes they just don't seem to work at all as a support/resistance tool and the judgment of when they'll work appears purely subjective.

Take a look at the daily chart of GBPUSD:

In the center of the chart we can see that price has declined to the Bollinger low and on first touch it does bounce only to fall below the lower band and does so on three consecutive days. On the day before the absolute low Rapid RSI moves into the oversold extreme. Does this mean we can buy? Maybe. Sometimes it works and sometimes it doesn't.

So what should we do?

The following chart is the 2 hour chart showing the approach to the low at 1.9400.

On the left of the chart we can see that price falls below two identical lows and these can then be considered as pivot resistance. We then see the three pushes lower and on the daily chart we know that the Rapid RSI went into an oversold extreme.

Do we buy at that point because is looks like the Rapid RSI on the 2 hour chart is developing a bullish divergence? The answer is "no." Divergences should only be traded on a break of a pattern. In this case we have an intermediate downtrend line and it is only after the final low that price breaks above the trend line and thus confirms the bullish divergence in Rapid RSI. You will also note that following the break above the trend resistance that price reverses briefly to retest the trend line which provides a second buying opportunity.

Following the break of the trend line which was the day after the daily oversold reading price rallies by 200 points. That's a good profit… Not only that, by waiting and observing the 2-hour chart you can avoid trying to pick the bottom as suggested in the daily chart.

Remember, it is normally best not to try and pick tops and bottoms as these will often provide losing trades. Waiting patiently for the right signal by fine-tuning the entry on a shorter time frame chart can reduce losing trades and make the final trade a more profitable one.

Using Multiple Time Frames in Your Analysis

A technique to improve your trading decisions

Have you ever seen RSI overbought and wonder whether it was the right time to sell? Let's face it, an overbought reading in a momentum oscillator can merely mean that price is strong and may even turn into an uptrend.

Is it a valid overbought signal? Do you sell? Where do you sell? Where should you place your stop?

Quite often using two charts of different time frames can help. For instance, let us suggest you have seen an overbought reading in the daily chart but there is no bearish divergence. What you can do is look at a shorter time frame chart, a 4-hour or 2-hour chart to see what is happening there an whether a more accurate sell signal can be identified.

Let us look at recent example in EURUSD:

Above is the daily chart of EURUSD as it approached 1.3258. Daily Rapid RSI was showing an overbought reading but there was no bearish divergence. From this chart alone we probably couldn't work out whether there was a selling opportunity or not.

This second image is the 2-hour chart of EURUSD but here it can be seen that the peak at 1.3258 was accompanied by a bearish divergence in Rapid RSI. We are therefore on warning that a reversal can occur and that the daily overbought reading may well be correct.

Next we have to identify a selling level and in this case it is on the break of the price support line which has touched price four times before it finally breaks and this is where we can place our sell-stop. The money management stop should ideally be placed above the 1.3258 high but if this is too high and would cause a large loss then we can look at placing a stop above the rising trend line. However, do note that is a rising trend line and could mean that your stop needs to be raised to allow a possible retest of the line.

In this case the trade would have been very profitable with a decline down close to the daily pivot support which rests around 1.3050. A take profit order can be placed just above this to exit the position at a tidy profit.

Using Multiple Time Frames in Your Analysis

A technique to improve your trading decisions

Have you ever seen RSI overbought and wonder whether it was the right time to sell? Let's face it, an overbought reading in a momentum oscillator can merely mean that price is strong and may even turn into an uptrend.

Is it a valid overbought signal? Do you sell? Where do you sell? Where should you place your stop?

Quite often using two charts of different time frames can help. For instance, let us suggest you have seen an overbought reading in the daily chart but there is no bearish divergence. What you can do is look at a shorter time frame chart, a 4-hour or 2-hour chart to see what is happening there an whether a more accurate sell signal can be identified.

Let us look at recent example in EURUSD:

Above is the daily chart of EURUSD as it approached 1.3258. Daily Rapid RSI was showing an overbought reading but there was no bearish divergence. From this chart alone we probably couldn't work out whether there was a selling opportunity or not.

This second image is the 2-hour chart of EURUSD but here it can be seen that the peak at 1.3258 was accompanied by a bearish divergence in Rapid RSI. We are therefore on warning that a reversal can occur and that the daily overbought reading may well be correct.

Next we have to identify a selling level and in this case it is on the break of the price support line which has touched price four times before it finally breaks and this is where we can place our sell-stop. The money management stop should ideally be placed above the 1.3258 high but if this is too high and would cause a large loss then we can look at placing a stop above the rising trend line. However, do note that is a rising trend line and could mean that your stop needs to be raised to allow a possible retest of the line.

In this case the trade would have been very profitable with a decline down close to the daily pivot support which rests around 1.3050. A take profit order can be placed just above this to exit the position at a tidy profit.

Intersecting Lines of Interest

Any technical analysis tool is designed to identify the price level, with the greater probability of representing a future market turning point. Any trend line or indicator used on its own may only produce a 50% rate of accuracy.

However when multiple lines indicate a similar price level and trade theory, then our chances of being accurate may increase dramatically in our favor. For example, we can see based on the following (1-hour) chart, the GBPUSD recently broke down below a common trading range. During these consolidating ranges, traders may adopt a simple buy low, sell high approach. Most recently we can see resistance emerged in the form of a ‘double top’ pattern, which occurred very close to the longer term 50% Fibonacci retracement level. In addition, due to the fact that the overall trend appears to be to the downside, those trading with the trend, may choose to maintain at least a small position in the hopes of greater profits as this trading range turns once again into a trend.

The Stochastic Kiss Pattern

A unique way to utilize the stochastic indicator

Here is a simple technique I devised some years ago and introduced to the institutional market. It takes one of the markets' favored indicators Stochastics and identifies a pattern that when used in conjunction with other analysis can provide great trades.

It is called the "Stochastics Kiss" simply because of the appearance of the fast stochastic line dipping towards the slow line (in a move higher) or blipping higher towards the slow line (in a move lower) and then reversing the next bar.

It looks like this:

The image shows a section of slow stochastics, the blue line being %Fast D and the green line %Slow D. Note that during the strong rise in %SlowD on the left how the %FastD pulls back and then rises again the very next bar. It is effectively showing that price has corrected lower within the range but failed in the decline and caused a reversal back higher.

Equally, on the right we have the opposite. During the strong decline in %SlowD the %FastD pulls back higher and then drops again the very next bar.

These can often provide good trades that can be held for one or two bars at least and occasionally longer.

When looking at this pattern the very best examples are those where the %SlowD maintains the same direction as at Point 1. The %Fast D line moves up towards the %SlowD line and then reverses lower and a sale can be made on close. Note that after two bars profit is taken on close.

Point 2 is not a valid example with the rally higher and reversal in %FastD occurring while %SlowD has no direction. At Point 3 the same thing happens as at Point 2 so should not be used.

However, at Point 4 we see a valid pattern. It is not as clean as the first example since as %FastD dips and reverses higher %SlowD does the same but recovers to be higher again and more importantly higher than two bars prior. Again, a two day trade reaps profit.

What is important with this type of strategy is that price action is also scrutinized. It is important that the price extreme on the single bar move in %FastD does not penetrate a previous swing high or low. Remember the definition of an uptrend is that both highs and lows are moving higher and vice versa in a downtrend.

This most certainly occurs at Point 1 with the sharp correction in price remaining below the previous swing high. Equally, at Point 4 the corrective dip in price remained above the previous swing low and thus the underlying directional move remained intact.

Here is a second example of where this pattern has worked well:

This is the daily chart of the Pound versus the U.S. Dollar where we have seen two good sell signals and one buy signal, all making good profit.

I should add a few instances where it would be wiser to be cautious and possibly not take the trades. There are basically two things to look for:

• Where the Stochastic is either overbought or oversold. These could be considered but will require confirmation from price movement. However, quite frequently because of the extreme reading of the Stochastics there is a higher instance of the pattern breaking down.
• Where the reversal bar that completes the kiss pattern has seen a strong reversal that takes out the extreme of the last two bars then there is a risk of a delay to follow-through. Again any positions taken should be well guarded by a close stop loss.

You may also find that using the support and resistance levels from Pro Commentary, available through Dealbook may also provide guidance towhen to use this pattern.

Using Pivot Levels

Utilizing pivot areas along with your analysis can strengthen support and resistance

Not too many books will discuss the use of pivot levels, mostly the topic being covered as being calculated mathematically through the use of daily highs and lows. However, the is an alternative way of looking at pivot levels which, albeit subjective, can provide excellent trading opportunities.

Many years ago the concept of using prior support and resistance levels as pivotal areas became clearer to me after a discussion with a trader who had scant interest in technical analysis. I had just gone through the usual daily analysis and provided my report to the traders. For a moment I chatted within one trader who declared that he agreed with one of my resistance levels.

Now being dedicated to technical analysis I was rather intrigued how a trader who didn't pay any real attention to technicals could agree with a resistance level so I asked him how he arrived at that level also. His reply opened up an explanation to me on why these techniques often provide good trading opportunities.

His response was that when he was trading the same currency several weeks before he kept using this level as support and made profits on several occasions until price finally dipped below that support. He concluded that it would provide the same effect on the way up again.

Effectively, what he was describing was traders' memories, these being determined by the emotions of having made or lost money. Thus pivot levels represent emotions, the fundamental basis of technical analysis.

So how will these look?

It is quiet clear that in this 4-hour chart of the Euro against the US Dollar that price has been moving in each direction in steps, stalling in the general area of the previous major support or resistance. For example, the Euro rallied from the bottom left of the chart to bounce from the same level as the prior two troughs. Very simply this represents the basic theory that support remains as support until broken and once broken will provide resistance (and vice versa.)

Following the breach of the two prior lows price rallied and sees a correction. We cannot determine from this chart whether this was at a previous support level. However, the rally continues quite sharply and then corrects lower.

It then retraces back to a previous resistance level following which it reverses lower once again, breaking the previous corrective low and stalls in the area of the first price peak in the rally. In the subsequent rally it initially bounces from the first trough on the way down.

It will be useful to have these levels match with overbought/oversold levels in momentum studies and hopefully, in shorter time-frame charts, to displays bullish or bearish divergences at these pivot levels. If this occurs it provides a stronger signal for a bounce.

At times it is possible to use pivot levels and pivot lines. The latter occur when price oscillates around a line that is not horizontal but more like a trend line only there is no trend:

This is the daily chart of the British Pound against the Japanese Yen. Note how the price point ringed in black occurred when testing both a pivot support area and a pivot line support. These can be particularly effective in cross markets when used with charts constructed by a line on close.

Thus, do take note of these pivot levels as when companied with Fibonacci retracements or projections they can provide you with excellent trading opportunities.

Directional Channels

The FX-market will normally oscillate between range bound and trending conditions a few times throughout the year. We may see the market spend a relatively low or high amount of time in either market condition, depending on the fundamental picture and economic climate of each currency within the pair. However it is safe to say that the FX-market has the tendency to remain in a range bound condition the majority of the time due to a number of reasons including the extremely high amount of volume that passes through the market every trading day. With that said, although boring, these trading ranges can offer a number of clues as to the future possible move of the market. The following (daily) chart shows the EURUSD pass through a number of trading ranges or trading channels, broken up only by an occasional trend, which tends to occur and terminate quite quickly. Note how the subsequent breakout was forecasted by the direction of the preceding channel. In other words, each trading channel developed a bias either to the upside or downside, which eventually broke out to a new trend in that same direction. What is the lesson? We should make every attempt to trade in the same direction as the overall trend. By placing our trades in the same direction as the overall trend, we stand a good chance to participate in the subsequent breakout if it happens to occur while we hold a position open.

Simple Moving Averages: BELM SELESAI

I take a "toolbox" approach to analyzing and trading markets. The more technical and analytical tools I have in my trading toolbox at my disposal, the better my chances for success in trading. One of my favorite "secondary" trading tools is moving averages. First, let me give you an explanation of moving averages, and then I'll tell you how I use them.

Moving averages are one of the most commonly used technical tools. In a simple moving average, the mathematical median of the underlying price is calculated over an observation period. Prices (usually closing prices) over this period are added and then divided by the total number of time periods. Every day of the observation period is given the same weighting in simple moving averages. Some moving averages give greater weight to more recent prices in the observation period. These are called exponential or weighted moving averages. In this educational feature, I'll only discuss simple moving averages.

The length of time (the number of bars) calculated in a moving average is very important. Moving averages with shorter time periods normally fluctuate and are likely to give more trading signals. Slower moving averages use longer time periods and display a smoother moving average. The slower averages, however, may be too slow to enable you to establish a long or short position effectively.

Moving averages follow the trend while smoothing the price movement. The simple moving average is most commonly combined with other simple moving averages to indicate buy and sell signals. Some traders use three moving averages. Their lengths typically consist of short, intermediate, and long-term moving averages. A commonly used system in futures trading is 4-, 9-, and 18-period moving averages. Keep in mind a time interval may be ticks, minutes, days, weeks, or even months. Typically, moving averages are used in the shorter time periods, and not on the longer-term weekly and monthly bar charts.

The normal moving average "crossover" buy/sell signals are as follows: A buy signal is produced when the shorter-term average crosses from below to above the longer-term average. Conversely, a sell signal is issued when the shorter-term average crosses from above to below the longer-term average.

Another trading approach is to use closing prices with the moving averages. When the closing price is above the moving average, maintain a long position. If the closing price falls below the moving average, liquidate any long position and establish a short position.

Here is the important caveat about using moving averages when trading futures markets: They do not work well in choppy or non-trending markets. You can develop a severe case of whiplash using moving averages in choppy, sideways markets. Conversely, in trending markets, moving averages can work very well.

In futures markets, my favorite moving averages are the 9- and 18-day. I have also used the 4-, 9- and 18-day moving averages on occasion.

When looking at a daily bar chart, you can plot different moving averages (provided you have the proper charting software) and immediately see if they have worked well at providing buy and sell signals during the past few months of price history on the chart.

I said I like the 9-day and 18-day moving averages for futures markets. For individual stocks, I have used (and other successful veterans have told me they use) the 100-day moving average to determine if a stock is bullish or bearish. If the stock is above the 100-day moving average, it is bullish. If the stock is below the 100-day moving average, it is bearish. I also use the 100-day moving average to gauge the health of stock index futures markets.

One more bit of sage advice: A veteran market watcher told me the "commodity funds" (the big trading funds that many times seem to dominate futures market trading) follow the 40-day moving average very closely--especially in the grain futures. Thus, if you see a market that is getting ready to cross above or below the 40-day moving average, it just may be that the funds could become more active.

I said earlier that simple moving averages are a "secondary" tool in my trading toolbox. My primary (most important) tools are basic chart patterns, trend lines and fundamental analysis.

Using Two Popular Oscillators: Slow Stochastics and Relative Strength

Two of the more popular computer-generated technical indicators are the Slow Stochastics and Relative Strength Index (RSI) oscillators. (An oscillator, defined in market terms, is a technical study that attempts to measure market price momentum - such as a market being overbought or oversold.)

I'll define and briefly discuss these two oscillators, and then I'll tell you how I use them in my market analysis and trading decisions.

Slow Stochastics:

George Lane has been called the father of the stochastic indicator. I met this gentleman a few years ago. He and his wife still attend and participate in trading seminars around the U.S. Lane's basic premise is as follows: During periods of price decreases, daily closes tend to accumulate near the extreme lows of the day. Periods of price increases tend to show closes accumulating near the extreme highs of the day. The stochastic study is an oscillator designed to indicate oversold and overbought market conditions.

Some technical analysts, including me, prefer the slow stochastic rather than the normal stochastic. The slow stochastic is simply the normal stochastic smoothed via a moving average technique. The slow stochastic, like the normal stochastic study, generates two lines. They are %K and %D. The stochastic has overbought and oversold zones. Lane suggests using 80 as the overbought zone and 20 as the oversold zone. Some technicians prefer 75 and 25. I like to use the 80-20 figures.

Lane also contends the most important signal is divergence between %D and the commodity. He explains divergence as the process where the stochastic %D line makes a series of lower highs while the commodity makes a series of higher highs. This signals an overbought market. An oversold market exhibits a series of lower lows while the %D makes a series of higher lows.

When one of the above patterns appears, you should anticipate a market signal. You initiate a market position when the %K crosses the %D from the right-hand side. A right-hand crossover is when the %D has bottomed or topped and is moving higher or lower and the %K crosses the %D line. According to Lane, the most reliable trades occur with divergence and when the %D is between 10 and 15 for a buy signal and between 85 and 90 for a sell signal.

Relative Strength Index:

The Relative Strength Index (RSI ) is a J. Welles Wilder, Jr. trading tool. The main purpose of the study is to measure the market's strength or weakness. A high RSI, above 70, suggests an overbought or weakening bull market. Conversely, a low RSI, below 30, implies an oversold market or dying bear market. While you can use the RSI as an overbought and oversold indicator, it works best when a failure swing occurs between the RSI and market prices. For example, the market makes new highs after a bull market setback, but the RSI fails to exceed its previous highs.

Another use of the RSI is divergence. Market prices continue to move higher/lower while the RSI fails to move higher/lower during the same time period. Divergence may occur in a few trading intervals, but true divergence usually requires a lengthy time frame, perhaps as much as 20 to 60 trading intervals.

Selling when the RSI is above 70 or buying when the RSI is below 30 can be an expensive trading system. A move to those levels is a signal that market conditions are ripe for a market top or bottom. But it does not, in itself, indicate a top or a bottom. A failure swing or divergence accompanies the best trading signals.

The RSI exhibits chart formations as well. Common bar chart formations readily appear on the RSI study. They are trendlines, head and shoulders, and double tops and bottoms. In addition, the study can highlight support and resistance zones.

How I employ Slow Stochastics and the RSI:

First of all, these two oscillators--especially the RSI--tend to be over-used by many traders. As you just read above, some traders use these oscillators to generate buy and sell signals in markets -- and even as an overall trading system. However, I treat the RSI and Slow Stochastics as just a couple more trading tools in my trading toolbox. I use them in certain situations, but only as "secondary" tools. I tend to use most computer-generated technical indicators as secondary tools when I am analyzing a market or considering a trade. My "primary" trading tools include chart patterns, fundamental analysis and trend lines.

Oscillators tend not to work well in markets that are in a strong trend. They can show a market at either an overbought or oversold reading, while the market continues to trend strongly. Another example of oscillators not working well is when a market trades into the upper boundary of a congestion area on the chart and then breaks out on the upside of the congestion area. At that point, it's likely that an oscillator such as the RSI or Slow Stochastics would show the market as being overbought and possibly generate a sell signal - when in fact, the market is just beginning to show its real upside power.

I do look at oscillators when a market has been in a decent trend for a period of time, but not an overly strong trend. I can pretty much tell by looking at a bar chart if a market is "extended" (overbought or oversold), but will employ the RSI or Slow Stochastics to confirm my thinking. I also like to look at the oscillators when a market has been in a longer-term downtrend. If the readings are extreme- - say a reading of 10 or below on Slow Stochastics or RSI- - that is a good signal the market is well oversold and could be due for at least an upside correction. However, I still would not use an oscillator, under this circumstance, to enter a long-side trade in straight futures, as that would be trying to bottom-pick.

These two oscillators are not perfect and are certainly not the "Holy Grail" that some traders continually seek. However, the RSI and Slow Stochastics are useful tools to employ under certain market conditions.

The Most Effective Way to Utilize Fibonacci Ratios

Opening the power to forecast accurately

Fibonacci Ratios are used by many traders and analysts and in a variety of ways. They are a central requirement to my style of analysis but must be used carefully and in a way in which helps you understand the market. There are many analysts which use them in “clusters” identifying areas where several Fibonacci ratios lie which they consider strengthens the odds for a winning trade. This can help at times, but the problem with this type of analysis is that it doesn't really help you understand price behavior and what to expect, where price should move. To me, unless you have a strong grasp of the structure of price development, you risk making trading decisions that leave you puzzled when things go wrong.

Let's take a brief look at how the ratios are derived.

Leonardo Pisano Fibonacci was a mathematician born in 1170 in Pisa, Italy. He developed a simple sequence of numbers that has fascinating properties. He began by taking zero and adding 1. He followed by adding 1 to 1 to arrive at two. He then took each answer and added to it the previous number which produces the sequence:

0, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987 and so on…

Now the interesting feature to this sequence is in the ratios. From 1 onwards Fibonacci then calculated the results of dividing one number by the next in the sequence and vice versa, then performed the same calculations with numbers two apart in the sequence, then with those three apart and so on and came to the following:

It can be seen that as the number progress in the sequence the results are exactly the same. From the bottom line note the sequence of ratios:

0.146, 0.236, 0.382, 0.618, 1.618, 2.618, 4.236, 6.854

We can then derive further ratios by multiplying or dividing numbers in the sequence thus:

Even by multiplying or dividing one Fibonacci number by another the result is always another Fibonacci number. We can also add the reciprocal of 0.236 and 0.146 which provides numbers of 0.764 and 0.854, then include ratios of the first numbers to arrive at the following:

0, 0.146, 0.236, 0.382, 0.50, 0.618, 0.764, 0.854, 1.00, 1.618, 2.618, 4.236, 6.854

I also include 1.382 which, while not a true Fibonacci ratio does provide some excellent projections.

How to use Fibonacci most accurately

Most proponents of Fibonacci will base their entry levels on areas where various Fibonacci retracements or projections tend to develop in clusters. The chart below shows how this is generally achieved:

The technique is basically applied by measuring Fibonacci relationships by measuring various start and end points. In this example I have measured from point A to point C and also Point A to the very high. I have then measured from Point B to Point C and from Point B to the very high.

It can be seen that there is a cluster of Fibonacci lines around the 1.2450-1.2500 area and it is within here that price bounces to get to the 1.3367 high.

However, the process is very in-exact and doesn't really provide any information of what to expect, whether the support will hold and where price can eventually go. By utilizing a combination of Elliott Wave and Fibonacci it is possible to achieve a greater level of accuracy.

Within the ratios I also use are the 2/3 value of 66.66% and also a harmonic ratio of √2 which is 0.414 or 41.4%. I also use projections of 166.66%.

Now look at this example. After identifying the end of Wave (i) and the retracement in Wave (ii) I can take various ratios to establish the potential end of Wave (iii). Most commonly these are 138.2%, 166.67% and 223.6%. In this case Wave (iii) completed at the 166.67% projection. Once we have established the end of Wave (iii) we can derive possible Wave (iv) corrections that normally stall around 41.4% - 50% of Wave (iii). In this case Wave (iv) was 41.4% of Wave (iii). Again, once Wave (iv) has been established we can project an end to Wave (v) that is normally 61.8%, 66.67% or 76.4% of the distance from the beginning of Wave (i) to the end of Wave (iii) and added to Wave (iv). In this case Wave (v) found a high around the 66.67% projection.

Each wave will have internal waves and can be used to highlight the most likely stalling point in advance. In additon you will have an idea of how the move will develop and if it deviates from this pattern then it will give you and eary warning of breakown or incorrect wave count. Thus it is possible to have greater control over your expectations and trades.

While Elliott Wave is quite complex and needs a great deal of practice, it is the most accurate form of prediction and is well worth learning. If you find the process too difficult then it can be worthwhile subscribing to an Elliott Wave based forecasting service such as FX-Strategy's Pro Commentary.

Common Indicators and Simple Trading Rules

There are a number of simple strategies we can create with the use of two or three common technical indicators. The (1-hour) chart below shows the EURJPY over the course of around 1-week's trading period. The market initially broke to the downside, as the candlestick activity remained below the 20-SMA (Simple Moving Average) and steadily following the lower Bollinger Band to new lows. Once the market reversed direction back to the upside, trading then emerged above the 20-SMA, following the upper band to recent highs. This brief example provides us with the basis for a few simple trading rules:

1. We should make every attempt to trade only in the same direction as the current trend.
2. The trend can be defined by studying the market's position in regards to the Bollinger Bands and 20-SMA.
3. Protective stops should be placed below the lower band in uptrend's, and above the upper band in downtrends.
4. Finally, we may initiate a trade at or below the 20-SMA, while taking profits at the upper band; in up trending markets. The opposite holds true in down trending markets.

This strategy may have to be adjusted depending on the currency pair and market condition, however by analyzing a segment of our charts; we can begin to isolate specific conditions telling us when to trade, and when to simply wait…

Bullish and Bearish Divergence Signals

Using price/momentum divergence to identify trend completion

Momentum indicators are normally used more as overbought/oversold indicators with levels above an upper level between 70 and 80 suggesting potential for a reversal lower and a lower level between 20 and 30 suggesting potential for a reversal higher.

When used carefully with strong reference to price these signals can be quite accurate. However, it is also possible to utilize momentum indicators to warn of a deceleration of a trend and subsequent risk of and end to the trend.

The latter signals are normally highlighted by what are known as "divergences." These can be defined as:

Bullish divergence: Rising price highs in an uptrend while corresponding highs in the momentum indicator are declining

Bearish divergence: Declining price lows in a downtrend while corresponding lows in the momentum indicator are rising.

When price and momentum direction begin to diverge in this manner it is basically identifying that the speed of the trend is beginning to lose momentum and as such there is greater risk for the trend to reverse.

Note how in this diagram that price has been rising in a sequence of higher highs and lower lows (an uptrend) but over the last three price peaks the corresponding RSI has marked lower peaks in the indicator.

The chart above shows three examples of divergences. The first towards the left of the chart is a bullish divergence where price has been declining with lower highs and lower lows but over the final two lows the RSI (Rapid RSI) has seen a higher low.

This signals a reversal higher in price which then sees an strong uptrend develop until towards the right center of the chart at the top of the trend we note that while the two last price highs are still rising, the Rapid RSI below has seen a lower high on the second price peak. The break of the trend support line confirms reversal.

Finally, from the peak at the right center of the chart we see a downward correction develop within which the price lows move lower but the Rapid RSI lows fail to confirm the downward momentum and this bullish divergence signals a reversal higher once again.

Does this mean that every time we note a divergence forming in this way that we should enter a trade? Most definitely not. It is always vital that such signals are confirmed by price. Remember the definition of an uptrend is a series of higher highs and higher lows, and vice versa for a downtrend. Until the prior low (in an uptrend) is broken, there is no reversal of the uptrend. The opposite is true for the downtrend.

Look at the chart below:

You can see here that price is rising very consistently in an uptrend while an apparent bearish divergence develops in this weekly chart over a period of nearly one year. However, no downward reversal occurs. There are two features to note here. The first is that at no time does the prior low point in the uptrend ever get broken and the second is that towards the right of the chart the break above the divergence line (effectively a trend resistance in Rapid RSI) price then accelerates higher once again.

However, divergences when used in conjunction with signals generated from price are an exceptionally strong indicator of a reversal and can provide you with excellent trading opportunities.

End Year Market Illiquidity

Does year end illiquidity really cause technical analysis to become less accurate?

In short, yes.

One has to remember that one of the basic requirements for technical analysis is that there is mass psychology. Mass psychology means that all market participants are active, reacting to price movement and generating turnover which in turn contributes to the structure of classic chart patterns. On average it is estimated that daily Forex turnover is in excess of US$ 2 trillion, by far the largest of all global financial markets.

By the middle of December many players are beginning to close their books for the year resulting in a much lower level of turnover. This decline in turnover means that large trades tend to have a greater impact than in normal trading volumes. Market traders prefer to remain square or carry small positions since they do not want to suffer losses from such abnormal movements, effectively increasing the level of illiquidity.

Let me give you an example of a market with normal levels of liquidity. Some years ago the trading room I worked in heard of a large transaction in Dollar-Canada of around US$300million. This sort of size, however well it is handled by a trading desk is likely to cause some movement and one might expect at least 25-40 points. The Treasurer took a position of US$10 million in the direction of the order and indeed the rate edged higher by 10 points. Before being able to close the position the rate suddenly reversed and dropped by 50 points.

What had happened? By coincidence there was an order for US$500 million in the opposite direction. It highlights how there is no such thing as market manipulation in Forex and no such thing as insider trading.

I therefore argue that in comparison to other financial markets which have a much smaller daily turnover and are subject to insider trading and the ability of one large participant to have a more significant affect on price direction, Forex is probably the only true market which is perfect for technical analysis. It truly reflects mass psychology.

Returning to the subject of end-year illiquidity, what happens to technical analysis?

Well, I work heavily with Fibonacci and harmonic relationships which I utilize to help identify which movements are related. These produce both retracement targets in corrections and also projected targets for future movements running from 5 minute charts through to monthly charts. All shorter term movements should work within the framework of the longer term movements. During December and the early part of January is that these relationships get pushed out of whack. The wave structures are more erratic and without easy to identify relationships it is difficult to recognize which moves are related.

This most certainly occurred over the last two week in December in particular and it is only this week that there is a stronger build up of more normal wave movements. All in all these do fit into the daily and weekly moves but given that these longer term charts can see a variety of patterns the limits of the support and resistance are wider and the stronger accuracy of normal markets becomes more vague.

Thus, when considering your own analysis and trading do be aware of the attendant risks during these illiquid periods. December and early January are the most affected but there can be similar dips in liquidity, but not quite so extreme around major holidays or financial year ends such as end March, Easter and quite often in August. Try and keep your positions during these periods to the minimum and trade less.

"Vibrating Prices" and the Trading Philosophies of W.D. Gann

William Delbert (W.D.) Gann is regarded as one of the pioneers of technical analysis and market behavior. He wrote several books on stock and commodity trading and developed the well-known "Gann angles" and "Gann Fans."

Gann was born on a farm near Lufkin, Texas, in 1878. His rise to trading fame is a remarkable story. He was the oldest of many children on the farm, and did not even finish grade school. Back then, it was not uncommon for the oldest boy to quit school at a relatively young age and stay at home to help out on the farm.

However, W.D. did not want to be a farmer. He wanted to be a businessman. For a short period of time he worked for a brokerage in Texas while attending business school at night. He then set out for New York City in 1903.

In 1919, at the age of 41, Gann quit his job with a stock brokerage and set out on his own. He began publishing a daily market newsletter called the "Supply and Demand Letter." The newsletter covered both stocks and commodities and provided traders with his annual market forecasts.

In 1924, Gann's first book, "Truth of the Stock Tape," was published. A pioneering work on chart reading, it is still regarded as one of the best books ever written on the subject.

Gann's market forecasts during the Roaring Twenties were reportedly 85% accurate. The stock market in the 1920s was skyrocketing, but Gann didn't think the bull run would last. In his forecast for 1929, Gann predicted the stock market would hit new highs until early April, then experience a sharp break, and then resume with new highs until early September. Then it would top and afterward would come the biggest stock market crash in history.

After around 20 years in New York City, Gann moved to Miami, Florida for reasons of both health and personal preference. His "How to make Profits in Commodities" book came out shortly thereafter.

Following are the general tenets of Gann's trading philosophies and methods. I won't go into great detail on his specific methods in this feature. If you want to learn more about Gann's specific trading methods, I suggest you read his books, or books written about Gann, some of which are available at www.amazon.com.

Gann designed several unique techniques for studying price charts. His main theory uses three parameters to project changes in price trend and market direction. They are: Pattern, Price and Time. These parameters can exert their influence individually, with one or the other being more determinate under different conditions. But they are best applied in a balanced manner. The basic idea is that specific geometric price patterns and angles have special properties that can be used to predict future prices.

He believed the markets are geometric in design and in function, and they follow geometric laws when they're charted. All of Gann's techniques require that equal time and price intervals be used on the charts. Thus, a rise of one price unit over one period of time (1 x 1) will always equal a 45-degree angle. Gann believed that the ideal balance between time and price exists when prices rise or fall at a 45-degree angle relative to the time axis. This is called a 1 x 1 angle.

Gann angles are drawn between a significant bottom and top (or vice versa) at various angles. Deemed the most important by Gann, the 1 x 1 trend line signifies a bull market if prices are above the trend line, or a bear market if below the trend line. Gann felt a 1 x 1 trend line provides major support during an uptrend, and when the trend line is broken it signifies a major reversal in the trend. Gann identified nine significant angles, with the 1 x 1 being the most important.

Gann said each of his predetermined angles provide support and resistance depending on the trend. For example, during an uptrend the 1 x 1 angle tends to provide major support. A major reversal is signaled when prices fall below the 1 x 1 angled trend line. Prices should then be expected to fall to the next trend line (the 2 x 1 angle). As one angle is penetrated, expect prices to move and consolidate at the next Gann angle.

Prices have a way of repeating themselves--or "vibrating," as Gann put it. One can think of vibration in terms of periodic oscillation, the theory of waves, or cycles, as in cycle theory.

Gann said in his own words, "Through the law of vibration, every stock and commodity in the market place moves in its own distinctive sphere of activities, as to intensity, volume and direction. All the essential qualities of its evolution are characterized in its own rate of vibration. Stocks and commodities, like atoms, are really centers of energy, and therefore, they are controlled mathematically. They create their own field of action and power--power to attract and repel, which explains why certain stocks and commodities at times lead the market and turn dead at other times. Thus, to speculate scientifically it is absolutely necessary to follow Natural Law. Vibration is fundamental; nothing is except from its law. It is universal, therefore, applicable to every class of phenomena on the globe. Thus, I affirm, every class of phenomena whether in nature or in the markets, must be subject to the universal laws of causation, harmony and vibration."

There is no question that Gann's trading track record in the 1920s was truly remarkable. And, his trading methodology certainly has merit. However, I think the most important tenets of Gann's success were stated in a paper published by Gann's grandson, edited excerpts of which are below: "Delbert Gann of Lufkin, Texas, started with nothing. He and his family had no money, no education, and no prospects. But less than 40-years after overhearing businessmen talk on railroad cars in Texas, W.D. Gann was known around the world.

"Hard work pays. W.D. Gann rose early, worked late, and approached his business with great energy. Virtually all his education was self-administered. This teacher, writer, and prescient forecaster had a third-grade formal education. But he never stopped reading.

"Unconventional thinking may have its merits. W.D. was intellectually curious to an extraordinary degree. He was unafraid of unorthodox ideas, whether in finance or in other areas of life. He wasn't always right--none of us are--but he dared to pursue a better idea.

"And finally, the only lesson for traders I will venture to offer is W.D. Gann never stopped studying the market. Even after his forecasts happened, even after he achieved international acclaim. Although he believed in cycles, he also knew that markets are always changing and that decisions must be made based on today's conditions, not yesterday's."

W.D. Gann's personal characteristics, as related by his grandson, are strikingly similar to two other famous traders of Gann's same era: Jesse Livermore and Richard Wyckoff.