Technical Analysis of the week

TRADING IN THE ZONE

TRADING IN THE ZONE

In this edition and subsequent editions once, I would be sharing and applying some trading systems that had been duly tested and in-use by me and professional traders. Like I said in the last edition (Reality edition) creating a trading system must fit into one’s unique personality and risk nature so as to bring confidence and consistence in approaching the market environment. The market must be understood from its perceptive, therefore winning traders understands that the interplay of demand and supply sides of the market is influenced by market participant’s perception about what price means at any particular point in time. With this believe professional traders realized that the market should be perceived with a probabilistic mind-set. Trading in probability depicts the uncertainty principle which means anything can happen in the market environment. Profitable successful traders predefine their risks, has an organized, systematic and money-management approach to entering and exiting trades whether in a profit streaks or losing streaks this enable them trade without the four fears (fears of losing, missing out, being right and letting profit turn into loss) and also consistent in profit making.

As a result of my years of experience, I have discovered that successful traders trade with zones which determine their entry, stoploss, and take profit. All traders consciously or unconsciously trade within the zones. Most traders that understand zone trading profit greatly from them while those who do not understand this approach to trading sometimes makes lots of mistakes such as buying at the rally and selling at the dips. 

Zone trading is referred to as trading with points of reference which serves as resistance/support levels at any particular point in time. Price action tends to trend upward, downward and or sideways, therefore how would we be able to gauge in what direction, how fast and how far price can go? Watching price without any reference point would leave traders directionless, but watching with this frame that may probably serve as support/resistance point that gives one edge and or clue over what the market can probably do. It should be further noted that the resistance/support points are merely probability points against which you can gauge the direction and speed of price action. They can offer important clues as to where prices are going, but are not cast in stone.

Zone approach to trading somewhat tends to mirror human emotional behaviour in the market environment. Some of the zones are Pivot Point, Fibonacci, Elliot Wave, Quarters Theory, etc. I develop my trading systems on the basis of some of the widely used zone approach, my most favorable zone analysis tool which is what we are going to fully explain and work with in this article is the Pivot Point analysis.

Pivot Point Analysis

Pivot points are based on a mathematical formula originally developed by Henry Wheeler Chase in the 1930s but was repopularized by Larry Williams in his book How I Made One Million Dollars . . . Last Year . . . Trading Commodities (Windsor Books, 1979). Many have been proponents of this tool such as Don Lambert, Peter Bain, John Person, and so on. As well as so many books on the subject.

Pivot points are a mathematical formula designed to determine the next time period’s range based on the previous time period’s data, which includes, the high, the low, and the close price, the reason for using a time period is that it seldom reflects all market participants’ collective perception of value for that time period. Floor traders use pivot points to determine critical price and support/resistance levels. It is a relatively simple calculation that can be jotted on the back of a trading card for ease of reference. Off-floor traders who have the luxury of looking at monitors with real-time data feeds can adopt this technique as well.

Calculation of Pivot points

The traditional pivot points have seven (7) points constituting the resistances, supports and central pivot. They are calculated using data from the previous trading session. By looking at the high, low, and close numbers from the last trading session, you can calculate the next session’s pivot point as well as support and resistance levels.

Also mid- points are calculated in-between the resistances and supports. The following are graphical illustration and mathematical calculation of the points.

Pivot Point Calculation

Third resistance                                   (R3)                   (R3) = H + 2 * (P – L)

Second resistance                                                         (R2) = P - (S1 + R1)

Intermediate resistance level               (M4)                 M4 = R1 + R2/2

First resistance                                    (R1)                 (R1) = (2*P) – L

Intermediate resistance level               (M3)                 M3 = P + R1/2

Pivot point                                          (P)                   (P) = (H + L + C)/3

Intermediate support level                  (M2)                 M2 = S1 + P/2

First support                                        (S1)                  (S1) = (2*P) – H

Intermediate support level                  (M1)                M1 = S1 + S2/2

Second support                                    (S2)                  (S2) = P – (R1 + S1)

Third support                                      (S3)                  (S3) = L – 2 * (H – P)

Due to technological advancement and numerous FX resource tools, one can download the pivot calculator which will automatically calculate the points after the appropriate data are inserted, moreso there are FX resource sites that does the calculation for some given periods sites like www.actionforex.com, www.dailyfx.com, www.fxstreet.com, and so on. There is also software that can calculate the points on your chart for any timeframe you want.

Pivot point usage

• Pivot point calculations help determine when to enter/exit positions.

• Pivot points help as leading price indicators for traders. They can help to project possible bias     levels to traders where price either change or continue its course.

• Pivot points are used to project support and resistance or actual highs and lows of trading sessions.

• Pivot points help confirm other technical methods.

• Daily, weekly, and monthly time frames should and can be used.

These numbers work very well and often act as a self-fulfilling prophecy because so many institutions and professional traders use them. The points if well understood can give traders edge in the market place, also the points can be incorporated with any trading system without distortion or complexity.

As much as the Pivot points has their strength so also they possesses their weaknesses because the market environment is an unstructured one where anything can happen and every moment is unique making it independent of previous outcome therefore good money/risk management combine with the right psychology will give traders higher edge when using the system.

Pivot Points Maxim

In simple terms, the maxims are selling at the resistance and buy at the support points. Resistances points are places to sell (it’s only an opportunity to sell but to actually sell when price action confirms the sell), a resistance can also become a buying point meaning it becomes a support zone when price breaks it upward. Likewise, Support points are places to buy (it’s only an opportunity to buy but to actually buy when price action confirms the buy), a support can also become a selling point meaning it becomes a resistance zone when price breaks it downward.

Remember, pivot point analysis is used as a guide; these numbers are not the Holy Grail.

Note the following extracts which I believe would aid your understanding of the PP system:

·         Resistance Level 3— this is the extreme bullish market condition generally created by news-driven price shocks. The market is at an overbought condition and may offer a day trader a quick reversal scalp trade.

·         Resistance Level 2— this is the bullish market price objective or target high number for a trading session. It generally establishes the high of a given time period. The market often sees significant resistance at this price level and will provide an exit target for long positions.

·         Resistance Level 1—this is the mild bullish to bearish projected high target number. In low-volume or light-volatility sessions or in consolidating trading periods, this often acts as the high of a given session. In a bearish market condition, prices will try to come close to this level but most times will fail.

·         Pivot Point—this is the focal price level or the mean, which is derived from the collective market data from the prior session’s high, low, and close. It is the strongest of the support and resistance numbers. Prices normally trade above or below this area before breaking in one direction or the other. As a general guideline, if the market opens above the primary pivot is a buyer on dips. If the market opens below this level, look to sell rallies.

·         Support Level 1—this is the mild bearish to bullish projected low target number in light-volume or low-volatility sessions or in consolidating trading periods. Prices tend to reverse at or near this level in bullish market conditions but most times fall short of hitting this number.

·         Support Level 2—this is the bearish market price objective or targeted low number. The market often sees significant support at or near this level in a bearish market condition. This level is a likely target level to cover shorts.

·         Support Level 3—in an extremely bearish market condition, this level will act as the projected target low or support area. A price decline to this level is generally created by news-driven price shocks. This is where a market is at an oversold condition and may offer a day trader a quick reversal scalp trade.

Pivot Point and Timeframe Analysis

The next questions that may arise are:

What timeframe is appropriate for calculating the pivot points of a given period?

What combination of timeframes can a trader use to determine the trading edge in using the pivot point system?

Traders can either be an intra-day trader or an inter-day (position) trader. An intra-day trader is one that places and closes an order within the day (24 hour trading) such can either be a scalper or a swing trader while a position trader trades beyond the day, such a trader holds on to trades/positions for more than 24hrs it can be within the week, months or year. In determining the appropriate time period to calculate the pivot points depends on the type of trader you are. Intra-day traders concentrates on shorter timeframes to calculate the Pivot points while position traders focuses on the higher timeframes. For instance, swing traders calculate the Pivot points using the daily chart while position traders uses the weekly or monthly charts. There is no limitation to the time period you can use to calculate the pivot points.

Irrespective of the kind of trader you are, the choice of the period is a function of the type of trader you are. The maxim of technical analysis is that the trend is your friend meaning trading with the trend and focusing on the higher timeframe to determine the direction of the market. Based on this notion it is appropriate to determine the possible resistances and supports from a higher timeframe and enter with the lower timeframe based on the points and your other trading variables that give you the edge. I personally use the daily chart to determine the pivot points, plot the projected resistances and supports point on the hourly chart which gives me the entry and exit (I also use other variables to aid the edge the PP system gives me). Some traders use single timeframe or multiple timeframes to analysis. In the choice of timeframe, a trader must understand his personality, risk tolerance level and style of trading.  

Pivot point and Trend analysis

In the market we say the trend is your friend. Price behaves in a trending manner either upward, downward or sideways. Irrespective of the price movement a trader’s obligation is to identify and take advantage of such movement. Pivot point system can serve as a tool to mirror or gauge market participant’s behaviour which reflects on the price in relation to time. For instance when price moves from S3 to R1 we say price is trending up on the other hand when price breaks R2 to S1 we may say price is trending down.

Aside from using Pivot point analysis to project trend, it can also be used in conjunction with other variables to confirm trend, technical variables such as indicators, trendline analysis, price, candle and chart patterns are example.

Trading using trendline analysis is also a form of determining the price trends, resistance and support levels over a particular period of time. Trendline analysis can also help for entry and exit of orders. Trendlines can be drawn by connecting previous high/low with current high/low respectively. In an upward price movement the trendline is referred to as the support trendline where lows are connected while in a downward price movement, the trendline is referred to as resistance trendline. In drawing a support trendline (uptrend) we connect the previous low with the current low, While the resistance trendline (downtrend), we connect the previous high to the current high. We determine a support/resistance if atleast two candle’s low/high on the left and right sides are above the low/high of the candle respectively.

The chart above show both resistance and support trendlines.

A breakout in the trendlines either resistance trendline(in a downtrend) or support trendline(in an uptrend) gives us either long or short respectively.

The above EUR/USD 1hr chart shows a breakout in the resistance trendline while the chart below shows a breakout in the support trendline. A breakout is successful if the candle in any particular timeframe closes below or above the trendline.

In a ranging market, we draw the resistance trendline and support trendline, waiting for a breakout in either trendlines so as to take appropriate action irrelation with the price movement.

Using trendline analysis with Pivot Point system

Somehow both trendline and pivot point analysis serve the same purpose of determining the R-S levels, also entering and exiting position(s). Both analyses can be used to filter out the whipsaw that each individual tool may generate.

In the chart above, the support trendline was broken touching the central pivot point therefore a confirmation surfaced when the CPP was broken downward signifying a short entry. The EUR/JPY 1hr chart show that the price breaks M3 and support trendline at 113.35 and 113.22 respectively, therefore we place a short immediately the candle closed at 113.10.

Let’s consider the following scenario:

1.      Price action breaches the pivot point confirmed by trendline breakout around the pivots, and then we consider the signal as a strong edge that can produce higher probability for success in such direction,

2.      If price fails to close above or below a pivot points and also fails to break a trendline we consider price to follow suit in its initial direction considering it as a corrective move,

3.      Price breaks a pivot point but fails to break a trendline, we may consider an entry based on average edge to winning the trade, or we wait for confirmation for trendline breakout.

I personally approach this system by drawing the daily pivot points and mid-points on the 15mins & 1hr charts, all I do is wait till price reaches any pivot on the 1hr chart then scale down to 15mins chart for trendline breakout in the direction of the 1hr chart.

Pivot points with price behaviors

The price reflects the behaviour and beliefs of market participants. Traders determine the direction of the market on what they give as the meaning of price at any particular period of time; therefore, understanding price behaviour is the utmost edge that a trader can have in the market environment. The forces of demand and supply at any particular period of time create patterns the market will interpret thereby stimulating actions on traders who are already actively in a position or on the sideline waiting to act. Price behaviour which forms patterns can significantly determine market direction based on traders perception. Price, candle and chart patterns aids decision making for traders, I would explain some of the important patterns and how to incorporate them with pivot points analysis to determine entry and exiting positions (there are numerous books published about patterns for further study mail bsgforex@yahoo.com and I will send you some in my library).

Trading with candle pattern: The following are examples of candle patterns and how to use with Pivot points

Doji:

                   

Price opens and closes at the same point meaning that the market is tired. When this pattern is formed on or around a pivot point it may signify a trend change or market relaxing to continue its initial movement, therefore it’s better to wait for confirmation candle.

 

Spinning top:

The pattern forms a small body with long upper and lower shadows. This reversal pattern may signify change in market bias when it surfaces at the top or bottom of an upward or downward trend respectively, moreso if it coincides with a pivot point number, it will be better to wait for a candle to form which will break either the high or low of the shadow.

 

Bull Engulf Pattern

White real body wraps around preceding black real body. Market in down trend

Implication: Market bottoming out

Bearish Engulf Pattern

Black real body wraps around preceding white real body. Market in up trend

Implication: ‘Bulls have been constrained”

Railway Track

Real body of two immediate candles of factually the same size.

Implication: Reversal pattern in trend.

Inverted Hammer

A small body and a long shadow, it shows a change in market flow.

The above candle formations are the important once for reversal or continual signals, there are many more other candle formations and like I said earlier on get books on patterns (Steve Nelson’s books on candle and chart patterns). In the following chart examples we would look into how to use these patterns with the Pivot point analysis.

EUR/USD chart above showed a down trend on the 20^th July, 2010. At M4 an inverted hammer formed immediately confirmed by a bear candle, we place short at 1.2979 (arrow pointing down) placing our stoploss at 1.3015 above M4. As far as price was breaking the pivot points and at no point formed any candle pattern so we continue to trade the trend but when we show another hammer formed at the bottom at M1 we exited the trade going long exiting at 1.2900 when a spinning top formed.

In the above chart of EUR/USD 1 hour chart of 23th July, 2010, the previous trend had been uptrend from 22^nd, immediately we saw spinning top we exited our buy then waited for a confirmation candle instead a doji formed so we wait again for a breakout either above R1 or below M3, at the close of the candle it closed below M3, we initiated the short @ 1.2910 and our stoploss at 1.2955, we followed the trend until a spinning top formed at M2 so we exited our short waited for the next candle to complete its formation, at the bullish close above CPP we initiated another position in the uptrend exiting at 1.2900 while our stoploss was placed at 1.2800.

After a down trend in the preceding session the EUR/JPY of 29^th July, 2010 formed a hammer and engulf pattern at M2 (buy zone) on the hourly chart, we initiated a buy 113.54 with stoploss at 133.10 while take profit was placed at 113.98. we also placed a short below 113.87 when we saw two spinning top formed on the hourly chart placing our stoploss at 114.30 and exited the trade at 133.10.

Chart Pattern: the combination of candle formations to form patterns is simply referred to as chart/price pattern. Double tops/bottoms, symmetric triangle, ascending and descending triangle, head and shoulder, are examples of chart patterns. Our only focus in this article would be on double/multiple top and bottom, R-S levels.

Double top is when price formed a high forming a resistance and at a future period in the same time chart price comes to retest the same high thereby forming two highs around the same price, at that point we say it formed a double top looking for a short if price fails to break the previous high likewise in a down trend when price fails to break a previous low thereby forming a support, we say a double bottom had formed looking to go long.

Below is a chart that shows a double top generating a short reversal confirmed with the pivot point.

In the above example of EUR/USD hourly chart of 20^th July, 2010 we saw a double top at M4 (sell zone). Price failed to break the previous high of 1.3006 (it only testes it) closing below M4 also confirmed by a preceding bear candle confirming a short.

Pivot Point with Technical Indicators

Technical indicators are analytical tools that help give traders edge in making trading decisions; they assist in determining and projecting market trends/direction. Technical indicators are developed based on past price action in relation to time to predict future price direction. There are two types of technical indicators; trend indicators and oscillators (momentum indicators). In a simple term, trend indicators are simply trend confirming tools, in a layman manner they show you a trend after it had already being established examples are moving averages, Bollinger band, CCI, Parabolic SAR, etc., on the other hand the oscillators project trends before it start, they tends to determine when price reaches extreme levels in relation to a particular time period. Stochastic, RSI, and MACD are examples of momentum indicators. Like any other analytical systems, any technical indicator can be used independently to determine entry, exit and risk parameters. Due to whipsaw that can be generated from these systems it is better to filter out the false signals so as to have better and higher probability to winning trades. For further understanding of trend indicators there are so many resource materials and FX sites that explains them such as www.babypips.com (later in our publication we would look in-depth into the various types of indicators).

We would be using the various indicators in conjunction with the pivot point system to determine our edge and fake-out false signals that may be generated for the systems independently.

Pivot Point analysis with indicators:

Moving averages are the most widely used trend indicator used by most traders. Moving average can be simple, exponential, smoothed and linear weighted. The MA can be used as crossover (where two and or multiple MAs crosses each other upward or downward) or single average where it works with price action. Parabolic SAR is also another type of indicator in this category that’s being widely used by traders. The following chart gives graphical illustration of trend indicator and pivot point system.

In the above chart, after a break below the M3 on the hourly chart of EUR/USD we see a break downward of the 50 period SMA signifying a short. We can also observe that price retrace but did not cross the SMA 50 upward, therefore we hold unto the short.

In this second example, Parabolic SAR confirmed the sell after M3 was broken downward, also Stochastic which is an oscillator indicator signified that price was at bullish extreme when an inverted hammer formed at M4. Stochastic would be at bullish extreme if in an uptrend the momentum is above 80 and bearish extreme if in a downtrend the price momentum is below 20. Therefore in such extreme levels price is being projected to change course. RSI is also an example of momentum indicator which signifies extremes in the like manner as the stochastic. In the above every time price reaches extremes on the stochastic around the pivot point price tends to change course. At M4 stochastic was at bullish extreme, price began a down trend, also at M1 stochastic was at bearish extreme (below 20) where a long trade was initiated. There is also MACD  

The use of pivot point system with indicator is to confirm the trend whether in a case of crossover or extremes, the pivot point system helps to validate the trend.

Risk and trade management with pivot point system

Effective trading system must be able to give traders winning edge also assist in defining trader’s risk. Every analysis is geared towards four basic reasons: to set trading conditions/rules, determine entry, exiting a trade in terms of stoploss and systematically take profit.

The pivot point analysis independently or used with other trading tools can effectively used for entry and exiting a position(s). entry rules with the pivot point is always with a breakout in any point while take profit is always some pips before the next point while stoploss would be usually place some pips above or below the preceding points, more so support and resistance levels is also considered. Let us example the chart below so as to determine our approach for entering and exiting trades using the pivot points system.

The above chart is the 1hr chart of EUR/JPY August 30^th, 2010. The pivot points was calculated  based on the preceding daily high, low, and close prices (29/07/2010) and the resistance and support levels projected into the 30^th. In the above price opened at Resistance 1(signifying a sell), the moment price closes below R1 we entered short at 113.30 with a take profit of 113.10(5pips before CPP) and stoploss of 113.70(6pips above R1). The next hour candle hit our take profit giving us 25pips profit and also confirming the down trend so we placed another short @ 112.95 below CPP with a stoploss @ 113.15(10pips above CPP) and take profit of 112.70 (10pips before S1), this also meet our take profit with another 25pips profit. The price then fails to break S1, so we waited and a bull candle formed therefore we entered long for 20pips to hit 133.00 target before it got to CPP. Since price closed above CPP 113.05, we therefore place another long @ 113.40 which fails to activate, price therefore change course in the downtrend by closing below CPP and M2, we entered short @ 112.55 with a stoploss of 112.80 and take profit of 112.10 giving us 40pips profit. In all the total profit was 110pips.

Using the pivot point system predefining the risk is of utmost importance. I personally recommend the maximum of 3% risk level in any position, therefore in calculating my stoploss must be predetermined. When I discover that my stoploss pips numbers would be higher than my predefined 3% risk level, I adjust my units so as to accommodate the 3%. My take profit is always systematical because I take profit before price gets to the next pivot points irrespective of the risk-reward ratio.

Pivot Point trade setup

·         Calculate the pivot point based on higher time period so as to project the resistances and supports points,

·         Draw the points on a lower timeframe,

·         Technical indicators and or pattern (candle, chart or price patterns) can be incorporated on the lower timeframe,

·         Determine your entry, stoploss and take profit on the lower timeframe.

For instance, a position trader may use the weekly chart to calculated the Pivot points, plot them on the 4hr chart making entries and exits with the 4hrs probably adding some trading variables to aid the decision making. A scalper may use the hourly high, low and close prices to calculate the pivot point, draw them on the 5mins chart with other variable, making entries and exit on the 5mins chart. The approach to use should depend on the kind of trader you are and your risk tolerance level.

The pivot point system is not an holy grail because the market is a dynamic one where nothing is 100% perfect except price itself, it only serve as a mirror or gauge to market participant’s behaviors at particular period of time. It can help trades to trade within technical zones and also ensuring that traders don’t over trade or get emotional (avoid fear, greed and anxiety) while trading.

Like Fibonacci, Elliot Wave, Quarters theory, Tom Demark trendline, and so on, the pivot point can also serve as a better tool that may yield consistencies to traders. In the next article in this column, we would be studying another zone trading analytical tool thereafter navigate in the advance zone trading.

Happy trading month. See you next month

Currency Trading - 10 Benefits of Using Forex Currency Trading Software

Currency trading can be extremely profitable, especially for those who utilize forex currency trading software. Listed below are some of the benefits you can get..

Forex currency trading if done correctly, could see you earning profits that will enable you the financial freedom you've probably always wanted. On the other hand, if forex currency trading is done incorrectly, then you may be risking your investment. Before you take your first steps into the forex markets, you need to at least do some homework on currency trading. Understanding the basic mechanics of how the forex markets work should definitely ease you into things, along with the help of one other tool: Forex Currency Trading Software

By utilizing currency trading software, you can reduce many of the risks and pitfalls that are sometimes associated with this type of business. Currency trading software can not only scan the market and make trades for you pretty much on autopilot, but can also offer you priceless tips and techniques that will allow you to deal with some of the more delicate and unpredictable conditions occasionally seen in the forex markets. Other than making money for you with very little human intervention, what other advantages does owning forex currency trading software give you?

Really easy to use

Forget the idea of figuring out complex calculations in order to trade a profit. Currency trading software does it all for you through a really easy to use control panel.

You can work from home

Most people would love the opportunity to work from home and with forex currency trading software as well as access to the internet, you can trade from home or anywhere else you choose.

24 hour trading

Because of the high demand for currency trading, the forex markets are open 24 hours a day opening from Sunday 5pm EST until Friday 4pm EST, which means you can continue trading even while you are asleep.

No supervision required

The forex currency trading robot that lies within this software never sleeps, so the only thing it requires is limited human interaction to keep it updated in line with the manufacturer’s guidelines.

No commission to pay

People using the stock market will tell you straight off about the brokerage and clearance fees that you are required to pay. But with forex currency trading software, these fees are simply just not an issue. All you pay is the bid-ask spread, so you get to keep all the profits yourself.

The bid-ask spread

With forex currency trading, all you pay is the bid-ask spread. Basically there are two slightly different rates of exchange assigned to every currency pair which are the prices between the buy and the sell price. It is the difference between these rates for each currency quoted by the broker that will make them their money. The money changer will then earn their profit on the differences they placed on the exchange rates.

No need for the middleman

The forex currency trading robot has taken away the need for the middleman. Now you can deal directly with the broker through the software’s online electronic exchange function.

Better fluidity

With this market besieged with buyers and sellers every 24 hrs, Sunday to Friday, it is good to know that your forex currency trading robot will fulfill your transactions for you on time every time.

Utilizing greater leverage

Due to the sizable amount of leverage forex traders are granted, making substantial gains in profit can be made with surprisingly little capital. On the flip side, erring on the side of caution may be necessary when using this leverage as losses can blow up out of proportion as well.

Profiting from the bull and bear market

Profiting from the bull and bear market refers to the ability of earning money when the market goes up (the bull) and when the market goes down (the bear). The forex currency trading robot allows you to earn both ways.

So there you have it, you can forget making all these critical mathematical decisions and leave it up to forex robot to handle. You're able to trust it with risk calculations up to the last moment to maximize your trading profits but also minimize any losses. Forex currency trading software is really a must have in this business, a savior if you will. Once you know what you're doing, there surely is only one way you can go and that’s onwards and upwards.

If you would like to try currency trading successfully, and see a big return on your investment, then check out this best selling Forex Trading Software.

By Luis Garcia
Published: 8/25/2010