Foundations of Technical Analysis: Seeing the Forest from the Trees

Identifying opportunities and how to use leverage effectively- a review of our technical approach and examples that illustrate our trading methodology in practice.

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Becoming a Better Trader – How to Create a Trading Plan

The importance of a trading plan can’t be overstated, but yet the number of traders who don’t have one far outnumbers those who do. Without a comprehensive plan of attack it is easy to get off course. Your plan doesn’t need to overly detailed, a couple of pages or so will do. There are a few key components which should be included, but keep in mind there is plenty of room for flexibility so as to tailor it to your needs. Keep this acronym in mind – K.I.S.S. (Keep It Simple Stupid) – as you go about constructing your trading plan.

Whether you are a new trader building a foundation or an experienced trader struggling (happens to the best), here are 4 ideas for Building Confidence in Trading

Must have a trading plan

In anything we set out to do, if we intend on it having a shot at success, don’t we plan ahead? Some type of plan? Then so it should be with trading. Markets are too dynamic, full of too much uncertainty, to try and navigate them without a framework in place. Trading plans are imperative for creating consistent results. They are also excellent for identifying strengths and weaknesses and then adjusting so you gravitate more towards what works and further away from what doesn’t.

What to include in your trading plan

Analytical approach

This is straight forward; what do you use to identify set-ups? It doesn’t matter so much what you use, just that it makes sense and is used consistently. It could be some combination of price support and resistance, trend-lines/slope analysis, chart patterns, Fibonacci levels, moving averages, Ichimoku Clouds, Elliot Wave Principle (EWP), sentiment, fundamentals, etc. Perhaps all together something else.

Favorite trade set-ups

What set-ups work best for you (get you excited)? It probably goes without saying, but these should be at the core of your trading. Set-ups are based on the alignment (confluence) of any number of factors which make for a high conviction trading opportunity. If you are new to trading, then this will take some time to figure out, so be patient in making progress towards understanding what works best for you.

A set-up is one thing, but how you execute it is another. We discussed this in detail in this 3-part series (Trading Breakouts | Trading Pullbacks | Combining Breakouts & Pullbacks). To recap one key point: There is the set-up, then the method by which you will take advantage of the set-up. For example, three traders could identify the same consolidation pattern; one will buy the breakout, another will wait for the first pullback after the breakout, and the third trader will do some combination of the two. Knowing how you best execute trades and what works for you is important.

What markets will you focus on?

Not every market moves the same, not everyone has the same interest in trading the same markets. Know which markets you focus on. It’s a good idea to keep your universe relatively small, helps keep things simple, and allows you to learn the personalities of the targeted markets and/or currencies. You can take it a step further and focus on specific time-frames for each market category. For example, you may trade equity indices on a very short-term time horizon (days or less), but choose to trade FX from a swing-trader standpoint (several days to several weeks). You could also have dynamic exposure to one market over another, i.e. – 75% FX, 25% indices/commodities.

Time-frame, hold time

What is the intended hold time for your trades, on average? Are you a swing-trader, holding for several days to weeks using weekly/daily/4-hr charts, or do you focus on day-trading, with hold times of a few hours or less, thus using daily down to even a 1-minute chart? It could be some blend of the two.

We understand the difficulties of trading, which is why we’ve put together a variety of guides designed to help traders of all experience levels.

Risk management

While we discussed this later in the webinar, the order is certainly not indicative of its importance. Without good risk management none of the rest of the trading plan will matter, at least not for long… You need to know your risk tolerance and adopt a risk management strategy which fits you. Know how much risk-per-trade you will take and total account risk across several positions. What is the max number of positions you will hold at once? (Fewer are easier to manage.)

Have a max drawdown figure in place as ‘kill switch’ when things aren’t going well. For example, if you experience a drawdown of 10% you will either take a break or at the least reduce your trading size. Remember, job #1 is capital preservation. (For more details, check out this webinar on risk management.)

Handling adversity (and success)

When you hit the inevitable drawdown, what will you do to make sure it doesn’t become damaging? You should reduce your trading size or stop trading altogether for a short period of time so you can alleviate stress and figure out what is going wrong. It is very important to have a plan for this before it happens.

It is also important to have a plan in place for when things are going well. Overconfidence can be a killer and lead to a drawdown if not correctly managed. While it is good to press it when market conditions are conducive and you’re doing well, but you need to do so responsibly. Increasing your risk by 50% isn’t out of control, but suddenly quadrupling it is, and will likely lead to a frustrating outcome.

Have a routine for staying on track

You should set aside time to reflect on the week’s events and how you traded. It’s a good idea to regularly review your trading plan and make tweaks if necessary. Periodical trade review and journaling are excellent ways to ensure you are following the process you have outlined in your plan, as well as identify patterns in your trading. Save charts of trade set-ups which stick out to you or you did well/poorly on for review later on.

Be rigid with your plan, but not too rigid. This can take some time for the newer trader to fully understand, but you want to have some flexibility in following your plan so as to not become too robotic. Unless you are trading with an algorithm, there is a ‘feel’ component to trading which should be incorporated. The more experienced you are the more this comes into play. The purpose of a plan and rules is to give you a strong foundation and boundaries to operate within…

For the full conversation, please see the video above…

Enjoy the video? Join Paul or any of the team’s analysts live each week for webinars covering analysis, fundamental events, and education.

Past recordings you might be interested in: Handling Drawdowns; Risk Management; Analysis, keeping it simple; 6 Mistakes Traders Make; Focusing on the Process; Building Consistency; Classic Chart Patterns, Part I;Classic Chart Patterns, Part II

—Written by Paul Robinson, Market Analyst

You can follow Paul on Twitter at @PaulRobinsonFX

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Successful Bear Market Trading Strategies & Techniques

Key Takeaways from the Trading Podcast:

• How and when to adjust your position sizing when prices are volatile
• Freeing up your margin by using less capital
• Considering the opportunity cost of existing positions
• Live to trade another day (absorb losses without blowing up your account)

Adapting your approach in this trading environment is key to successful trading

In this week’s episode senior analyst, Tyler Yell, unpacks the recent spate of volatility in the markets and reveals how to tailor your approach to “Survive another day” should the move work against you.

Volatility has been cyclically depressed in recent years, appearing every so often but what we have seen in early 2018, and now toward the end of 2018, appears to be a pattern of volatility. So how should traders change their approach under such volatile conditions?

4 Bear Market Trading Strategies

Reduce position sizing

As volatility increases and price moves become more violent, reduce position sizes. Think of it this way, you can make twice as much money on half of the position in a bear market that exhibits 4 times its usual volatility. Reducing position sizes has the added benefit of keeping you calmer and help you to manage the emotions of trading.

Freeing up margin

An additional benefit stemming from lower position sizes is that you are left with more available margin. Put differently, you are using a lower proportion of your trading account which leaves ample room to take advantage of new trading opportunities. Typically, traders should have sufficient funds in the account to capitalise on volatility strategies such as, bear market rallies on short time frames and divergences that play out successfully.

Opportunity cost

This is probably one of the most overlooked bear market trading strategy as it is essentially a hidden cost. Regardless of the market, you’re looking for opportunities with an edge and in a fast-moving, volatile market, the positions that are losing tend to hold an opportunity cost that isn’t worth the potential profit.

By keeping an inventory of new opportunities, you’ll be less encouraged to keep losing trades and jump on new opportunities that volatility can take into the green quickly.

Live to trade another day

Keep the long-term in mind. The often-forgotten beauty of bear markets is that every day can present excellent opportunities for those that play both sides of the tape. While it may be exciting to trade large, one trade should never be so crucial that it can put you out of the game completely. James Stanley, who was recently interviewed on the show, sums it up perfectly when he says you should see each trade as Just One of a Thousand Insignificant, Little Trades.

Practical example of volatility seen in WTI Oil

A helpful indicator that traders use to identify volatility is the Average True Range (ATR), which describes how much a market moves, on average, over a specified time(blue line).

Looking at the chart above, you will see that from August to September the ATR hovered around 160 points or less. The first sign of increased volatility surfaced around early to mid October and jumped even further in November. Traders should view the consistently higher volatility in October as a signal to reduce trading sizes. Reducing the trading size has the added benefit of freeing up margin for new trading opportunities. Such an opportunity appeared as WTI turned sharply lower.

The opportunity cost for long traders, in this example, is clear to see. Holding on to a long trade as the market moves lower and lower will increase your margin obligation and prevent you from taking advantage of new (more profitable) trading opportunities.

Adopting these strategies will increase the chances of you living to trade another day during turbulent markets.

Helpful resources:

• If you are just starting out on your trading journey it is essential to understand the basics of Forex trading in our free New to Forex trading guide.
• Jeremy Wagner, Head Forex Trading Instructor, provides a practical approach to trading volatile markets that all traders should be aware of.
• If you are interested in a video example, Chief Currency Strategist, John Kicklighter, had produced an example on how to adopt a more Regimented Trading approach to volatile markets.
• Upward trending markets don’t last forever which is why all traders should be able to identify and trade a bearish reversal.
• Learn how to trade a bearish engulfing pattern.
• At DailyFX we researched over 100,000 live IG Group accounts to find out the secrets of successful traders and published the findings in our Traits of Successful Traders.

If you found this article useful, you should follow our weekly podcasts. Whether you are looking for market analysis, trading education or interviews with well-known industry professionals, we have you covered.

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Becoming a Better Trader – Fixing Mistakes, Working on Weaknesses

Small fixes can add up to big change

This may sound obvious, but this is an overlooked area of trader development – identifying weaknesses and turning them into strengths. It’s one of the reasons many trading mistakes are made over and over and over again. Even fixing the little stuff, making tweaks here and there can add to up to a big difference. Fixing a mistake in one area can help remedy a problem in another, and so on, it’s a process.

Whether you are a new trader building a foundation or an experienced trader struggling (happens to the best), here are 4 ideas to help you Build Confidence in Trading

It starts with keeping good records, journaling, and review

Without good records it is very difficult to pin-point problems let alone fix them. Going through your trade history can help you quickly see what you need to work on. For example, you can calculate risk/reward ratios, or see that you make money specific types of trades but lose on others.

In addition to looking at your trade history, a journal will help in identifying behavioral patterns which may need fixing. These are the hardest to remedy, but you can’t begin to address them if not brought fully into the light. The process of review should be done periodically, even if only once a week it can go a long way towards making progress.

We understand the difficulties of trading, which is why we’ve put together a variety of guides designed to help traders of all experience levels.

Take it slow and don’t overwhelm yourself

This will depend on your experience level, but you likely have several areas which need work. And that is OK. The key here is that you take it one step at a time and go slow. By trying to tackle all your issues at once you will become overwhelmed and frustrated.

Start with the most important. These are typically problems related to risk management. A topic we discuss weekly, for more check out this webinar dedicated to risk management. While talking about risk, another point to make is that some problems cross over into other facets of your trading, and so fixing one problem helps fix another.

For example, by trading within your personal risk tolerance you will avoid both larger drawdowns and find it easier to stick to predetermined stop losses and targets.

Be patient with your progress

There will be setbacks. Trader development is a process and can be a frustrating journey if not handled properly. So, don’t go hard on yourself if it takes longer than you like or think it should. Just be persistent and take it slow. If you find that along the way you start to slip and regress, take a step back, and, if needed, take a little time off to regain perspective.

It’s our competitive nature to want to push on through difficulties, but often times the best approach is to stop struggling and further tangling ourselves up in a mess. The problems and their solutions are more likely to appear when not trying too hard.

For the full conversation and examples, please see the video above…

Enjoy the video? Join Paul or any of the team’s analysts live each week for webinars covering analysis, fundamental events, and education.

Past webinars you might be interested in: Handling Drawdowns; Risk Management; Analysis, keeping it simple; 6 Mistakes Traders Make; Focusing on the Process; Building Consistency; Classic Chart Patterns, Part I; Classic Chart Patterns, Part II; Trading Breakouts; Trading Pullbacks; Combining Breakouts & Pullbacks

—Written by Paul Robinson, Market Analyst

You can follow Paul on Twitter at @PaulRobinsonFX

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A Complete Guide for Forex Traders

What are candlesticks in forex?

• Forex candlesticks provide a range of information about currency price movements, helping to inform trading strategies
• Trading forex using candlestick charts is a useful skill to have and can be applied to all markets

What could possibly be more important to a technical forex trader than price charts? Forex charts are defaulted with candlesticks which differ greatly from the more traditional bar chart and the more exotic renko charts. These forex candlestick charts help to inform an FX trader’s perception of price movements – and therefore shape opinions of trends, determine entries, and more.

All currency traders should be knowledgeable of forex candlesticks and what they indicate. After learning how to analyze forex candlesticks, traders often find they can identify many different types of price action far more efficiently, compared to using other charts. The added advantage of forex candlestick analysis is that the same method applies to candlestick charts for all financial markets.

Forex candlesticks explained

There are three specific points that create a candlestick, the open, the close, and the wicks. The candle will turn green/blue (the color depends on the chart settings) if the close price is above the open. The candle will turn red if the close price is below the open.

If you have the chart on a daily setting each candle represents one day, with the open price being the first price traded for the day and the close price being the last price traded for the day.

• Open price: The open price depicts the first traded price during the formation of a new candle.
• High price: The top of the upper wick. If there is no upper wick, then the high price is the open price of a bearish candle or the closing price of a bullish candle.
• Low price: The bottom of the lower wick. If there is no lower wick, then the low price is the open price of a bullish candle or the closing price of a bearish candle.
• Close price: The close price is the last price traded during the formation of the candle.

The image below shows a blue candle with a close price above the open and a red candle with the close below the open.

See our page on How to Read a Candlestick Chart for a more in depth look at candlestick charts

Why forex traders tend to use candlestick charts rather than traditional charts

Candlestick charts are the most popular charts among forex traders because they are more visual. Candlestick charts highlight the open and the close of different time periods more distinctly than other charts, like the bar chart or line chart.

Candlestick charts have certain advantages:

• Forex price movements are perceived more easily on candlestick charts compared to others.
• It is easier to recognize price patterns and price action on candlestick charts.
• Candlestick charts offer more information in terms of price (open, close, high and low) than line charts.

However, there are some disadvantages of candlestick charts:

• Candles that close green or red may mislead amateur forex traders into thinking that the market will keep moving in the direction of the previous closing candle.
• Candlestick charts may clutter a page because they are not a simple as line charts or bar charts.

How to trade forex using candlestick charts

Candlestick formations and price patterns are used by traders as entry and exit points in the market. Forex candlesticks individually form candle formations, like the hanging man, hammer, shooting star, and more. Forex candlestick charts also form various price patterns like triangles, wedges, and head and shoulders patterns.

While these patterns and candle formations are prevalent throughout forex charts they also work with other markets, like equities (stocks) and cryptocurrencies.

Trading forex using candle formations:

The hanging man:

The hanging man candle, is a candlestick formation that reveals a sharp increase in selling pressure at the height of an uptrend. It is characterized by a long lower wick, a short upper wick, a small body and a close below the open.

It is a bearish signal that the market is going to continue in a downward trend. Learning to recognize the hanging man candle and other candle formations is a good way to learn some of the entry and exit signals that are prominent when using candlestick charts.

The chart below shows the GBP/USD on a weekly timeframe. This means that each candle depicts the open price, closing price, high and low of a single week. The hanging man candle below (circled) is a bearish signal. Traders use bearish signals like this to enter short trades, a bet on the GBP depreciating relative to the USD.

If a trader uses the hanging man to execute a short trade, he/she should then place a stop loss and a take profit with a positive risk-reward ratio.

The Shooting Star

A shooting star candle formation, like the hang man, is a bearish reversal candle that consists of a wick that is at least half of the candle length. The long wick shows that the sellers are outweighing the buyers. A shooting star would be an example of a short entry into the market, or a long exit.

Traders could take advantage of the shooting star candle by executing a short trade after the shooting star candle has closed. Traders could then place a stop loss above the shooting star candle and target a previous support level or a price that ensures a positive risk-reward ratio. A positive risk-reward ratio has been shown to be a trait of successful traders.

The Hammer

The hammer candle formation is essentially the shootings stars opposite. It is a bullish reversal candle that signals that the bulls are starting to outweigh the bears. It is characterized by its long wick and small body. A hammer would be used by traders as a long entry into the market or a short exit.

The image below is an example of how a forex trader would use the hammer candle formation to enter a long trade, while placing a stop-loss below the hammer candle and a take profit at a high enough level to ensure a positive risk-reward ratio.

Take your forex trading to the next level

Supplement your understanding of forex candlesticks with one of our free forex trading guides. Our experts have also put together a range of trading forecasts which cover major currencies, oil, gold and even equities.

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Becoming a Better Trader – What Is Your Trading Style?

Whether you are a new trader building a foundation or an experienced trader struggling (happens to the best), here are 4 ideas to help you Build Confidence in Trading

What type of trader are you? This might sound like an odd question, might sound like an obvious question. I don’t know. But I do know that a lot of traders can’t quite define right off the top of their head how it is they go about operating in the market. You should know and definitively so. For example, you might be a swing-trader who holds positions several days to weeks, relies heavily on technical analysis w/ one eye on how markets respond to headlines, and generally trades in the direction of the trend or tone of the market with a few exceptions. That was a description of my FX trading in a nutshell. Ask for specifics, like what forms of technical analysis I use, and I’ll give that to you too.

At the end of the day, there are no right or wrong ways here. The two most important factors are that your style resonates with you (own it with conviction) and that you consistently follow your methodology. The important questions discussed in this webinar were; What do you use to make decisions (forms of analysis)? How do you execute upon what you see? That is, do you trade breakouts, range-trade, hold for very short periods of time (day-trader) or longer periods (swing-trader), etc.?

We understand the difficulties of trading, which is why we’ve put together a variety of guides designed to help traders of all experience levels.

I also went over a couple of tips on how to find those markets or currency pairs which may be most conducive to your trading style. We can with reasonable accuracy identify a market where probabilities favor a breakout or increase in volatility, and those which are or could soon become a range-trader’s delight. Understanding market conditions is a very important factor which ties in with a trader’s methodology. Obviously not all market conditions are favorable for every style of trading and with the right information one can either avoid trading or least avoid certain markets, or pivot to a different strategy which fits the current environment.

For the full conversation and examples, please see the video above…

Enjoy the video? Join Paul or any of the team’s analysts live each week for webinars covering analysis, fundamental events, and education.

Past webinars you might be interested in:Handling Drawdowns; Risk Management; Analysis, keeping it simple; 6 Mistakes Traders Make; Focusing on the Process; Building Consistency; Classic Chart Patterns, Part I; Classic Chart Patterns, Part II; Trading Breakouts; Trading Pullbacks; Combining Breakouts & Pullbacks

—Written by Paul Robinson, Market Analyst

You can follow Paul on Twitter at @PaulRobinsonFX

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Trading in a Volatile Market

At times, the Forex markets can become extraordinarily volatile. For that matter, any market can, depending on what has been going on. You can be in a nice uptrend, only to have a headline crossed the wires that turn things back around to knock you down, causing massive losses. In this article, I’ll look at the special challenges when it comes to trading in a volatile market.

First things first: manage your risk

The first thing that you need to pay attention to its risk. For that matter, it should be the first thing that you pay attention to in any trading environment. Ultimately, if you don’t manage your risk, you will go broke trading and lose all your trading capital. That’s always going to be the first thing that you should think of when putting money to work.

If situations continue to become very volatile, then you are looking at a situation where protecting your risk becomes even more important, and therefore you should look into your trade size. For myself, one of the most effective ways I have found to protect trading capital in a volatile situation is to cut the position down. In other words, if you typically trade 0.5 lots, then you may wish to trade 0.25 lots because of the inherent risk in a market that can move very rapidly.

Understand that professional traders will be forced by risk managers to cut down their position size as well. For that matter, professional traders tend to trade with much less leverage than the retail trader. It’s not uncommon at all to see a professional trader using 1:7 leverage, instead of the 1:200 that a lot of retail traders will use. Part of this is because the professional trader has a larger account, sometimes going into the millions of dollars depending on the situation and/or bank they are working for. When you make a 5% gain, it means much more in that account than it does in a $2000 account.

The trend becomes even more important

When trading in a volatile market, the overall trend becomes much more important. While volatile markets typically denote some type of trend change, the reality is that the longer-term trend tends to be what the market pays attention to overall. Because of this, if you are in a volatile market you may wish to only trade in the direction of the longer-term trend, meaning that you need to sit on your hands occasionally. I think at this point, it’s likely that the best thing to do is wait for the larger money to come in and push in the right direction, as well as keeping your trade position smaller, because of the potential of losses.

Typically, a lot of volatility comes at the hands of fear and possible occasional headlines, but when you look at a Forex chart, most of the time they trend for years. There are times when things go back and forth rather drastically, but overall, I think that most of these moves end up being value propositions for those willing to jump into the fire. That doesn’t mean you should do so briskly, it just means that the longer-term trend still holds true for the most part. You should however have a “line in the sand” when it comes to the longer-term trend and recognize that a break down below or above that line represents a change.

Once the longer-term trend changes, it changes the overall strategy when it comes to trading, but this as a general rule should be something that is based upon weekly, if not monthly charts. While this could cause a lot of short-term pain, the reality is that eventually the longer-term trend reasserts itself most of the time.

Sometimes, it’s better to sit on the sidelines

Unless there’s some type of major geopolitical or global event, the reality is that you can almost always find a pair to trade that’s much less volatile. Ultimately, a lot of traders get married to a particular currency pair, not understanding that they all operate the same. In other words, if you are typically a trader of the EUR/USD pair, then you should perhaps look to another market if it has become too volatile. Exactly what is stopping you from changing the pair and start using the EUR/CHF pair? Just step away from the overly volatile currency pair, because it’s not worth it. At the end of the day you are simply trying to profit, not become a genius on a particular currency.

Higher time frames

Another thing that you can do when things get a bit volatile is simply go to higher time frames, which will naturally make you cut down your position size. For example, you may typically trade the hourly chart and risk something along the lines of 50 pips on average. However, if you are forced to trade the daily chart, you may need to risk 120 pips on average. You still want to risk the same amount of capital per trade, so you will have to start out with a smaller position in let the market work its magic over time. This forces you to focus on the big picture and pay attention to the overall attitude of the market instead of the day-to-day noise.

Turn off the news

You should be cautious about paying too much attention to headlines, because they don’t matter. What matters is where prices going, not what some politician in Brussels says, Donald Trump says, or anybody else. Markets are truth, and truth can be found in pricing. Beyond that, when things get too volatile you will find poor analysis much more likely, as even the best analysis can become less useful after just a few hours. You need to look at the big picture in these situations, and simply relax.

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How to Select Your Trade Entries

While knowing how to enter the market is only part of the equation, certainly you cannot make any money if you are not involved. This of course then means that your entries must make sense. While there is no “magic bullet” when it comes to entries for trades, there are some things that you should keep in mind when getting involved.

First things first: trend

The most important thing for your entry should be to understand whether you are going with or against the trend. In other words, if you’ve been rising in this market for months, and you are looking to buy the currency, then it means that you are trading with the trend. However, if you have an entrance into the market that is a short position, you are going against the longer-term trend.

As a general rule, it is much wiser to enter with the longer-term trend, as the big money will help you realize your gains much quicker than short-term speculators. When you look at a chart and it’s been rising for the last several years, it’s obvious that buying is the intelligent thing to do.

Moving averages

Some people will use a specific moving average situation to start buying. For example, a moving average crossover system is quite often used by trend traders. A trend trader will wait for a smaller time frame moving average to cross above a longer timeframe moving average to start buying, or vice versa. One of the most common ways that traders employ this strategy is to buy a currency pair won the 50 day EMA crosses above the 200 day EMA and sell when it breaks to the downside. However, you should also make sure that there is some type of momentum, and the market isn’t simply chopping sideways as that can cause a lot of whipsaw trading.

Candlestick patterns

While there are literally hundreds of candlestick patterns you can choose from, there are handful of them that catch most traders attention. I believe that probably the most important one is going to be the hammer or shooting star, as it shows a complete reversal. If you can marry that up with a major resistance level or perhaps even some other system, then you have several reasons to enter a trade. In the next section, I talked about Fibonacci retracement trading, and there is a perfect example of a shooting star that coincides nicely with a major Fibonacci retracement level that a lot of traders will be paying attention to.

Fibonacci retracement

There are a lot of traders out there that use Fibonacci retracement entries as well. Some of the most common will be the 38.2% Fibonacci retracement, the 50% Fibonacci retracement, and the 61.8% Fibonacci retracement. This is especially interesting when there is also a round number or previous support/resistance to back up a Fibonacci move as well. There is probably nothing truly magical about Fibonacci when it comes to trading markets, only that so many people pay attention to it and that’s in the end all that matters.

Typically, people will look for some type of candlestick pattern at one of those major Fibonacci retracement levels, and place their trade based upon not only a supportive or resistance candlestick pattern, but also the fact that so many people will be paying attention to these levels.

In the end, it’s not rocket science

I know that trading seems difficult at times and finding a good entry can be difficult. However, when you place a trade, there is still a certain amount of probability coming into play. I believe that the thing about trading is that you need to keep it simple. In other words, you need to know exactly what is working for you, and then pay attention to those factors. I believe that the best way to trade is to make sure that you have several simple and easily identifiable reasons to enter the market.

A perfect entry could be something like the following: you are in a market that has been in and uptrend for some time but has recently pulled back. That pullback has been a move down to the 50% Fibonacci retracement level on the daily chart, forming a hammer on the daily close. You also have the 200 day moving average just below the candle stick, and at the next day opening you see the market rally a bit and break above the previous candle stick that had formed the hammer. These are all reasons that some traders will come in and start buying this market. You have at least the trend, the retracement, the hammer, and the moving average all backing up your trading opportunity. That is for reasons much more important and much more likely to succeed than just entering the trade whenever.

However, I would point out that no matter how well put together this trade entry is, that doesn’t necessarily mean that it’s going to work out. There are no certainties when it comes to trading, so make sure that your money management is followed as well. After all, if you have 1% risk put into a trade that goes against you, it’s not a huge deal. However, if you get some type of major trade signal like the one mentioned previously and risk 10%, if the trade goes against you it will be very destructive.

Keep your entry simple and recognize that you need other people to push the market in your direction. It needs to be an entry that everybody can recognize, as it gives you the best opportunities to make money in the market which of course can be somewhat erratic and noisy at times. Remember though, nothing is 100%, and therefore make sure that you can accept losses when they come. That’s probably the other part of the equation when it comes down to entries in the Forex markets. This will be especially true if you are trading short-term charts.

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A Guide to Day Trading

By: XTB

What is day trading?

Day trading is defined as the buying and selling of instruments within a single trading day, but can apply generally to slightly longer timeframes. Typically, day traders utilise high amounts of leverage and short-term trading strategies to capitalise on small price movements, with the aim of making a small but not insignificant profit. There’s a lot of misinformation and controversy surrounding day trading – with the false promises of get-rich-quick schemes as well as a negative media portrayal – but as long as sensible risk management is applied, day trading can be an exciting and profitable source of income.

Can you make a profit from day trading?

Making profits from day trading is certainly possible, but so are losses if you do not approach day trading with discipline. It requires a good knowledge of the financial markets, as well as trading strategies that are geared towards short-term movement. Additionally, the use of leverage on even small price movements may give you the possibility of profits. However, leverage also gives you a bigger exposure to losses, so it’s important to manage your risk carefully with things like stop losses, trailing stops and other money management techniques.

Download XTB’s Day Trading Guide Video Strategies, In-depth Guide and free demo of our award-winning platform

What are the features of day trading?

There are several positives associated with this style of trading:
Reduce risk: Arguably the biggest benefit is that risk can be greatly reduced due to the lower amount of time that positions are typically left open. This leaves a far smaller time window for adverse developments to potentially occur and alter the course of the markets against you.

Trade with less capital: In light of the new leverage restrictions, traders may look to focus on shorter time frames to book profits more quickly and compound the growth of their capital.

Day traders look for two things in a market: liquidity and volatility. As day traders will be placing and closing several trades a day, a tight spread can be important to lower the cost of trading – while more volatility means greater movement in price, which can mean greater profits. However, your losses can also be magnified, so make sure you go through our Risk Management section in detail.

What strategies do day traders use?

Trading the News: Day traders use the momentum from macroeconomic events and trade on the back of news releases until the market exhibits signs of a reversal. Events like the non-farm payrolls or interest rate decisions from central banks can be the catalysts for large, volatile moves in the markets. Day traders look to capitalise on these by opening positions for a short amount of time.

Preparation is key here, as it is imperative to know what time these economic events occur and what the consensus market forecast and previous readings were. An example is the Canadian retail sales in July:

Source: xStation

To access two more day trading strategies, download XTB’s free guide which includes an in-depth ebook and three videos.

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Pullback Trading Strategies | DailyForex

One of the most common ways to trade financial markets is to use a pullback strategy. This simply means jumping into a market that has established a trend, and then has gone against that trend as markets typically do, forming an ebb and flow over time.

Think of it this way: if you are in an uptrend, you can’t go straight up forever. Quite often, traders will look for value in a situation like that, and by when the market falls slightly after an impulsive move higher. This gives traders who may have missed out on the initial surge higher an opportunity to get involved, which they almost always will try.

Obviously, it works in both directions. So if the market is falling over the longer-term, it will occasionally have a bit of a bounce, and sellers will jump in at that point. Pullbacks happen in both up and down trends.

A multitude of tools are available

A multitude of tools are available for pullback strategies, including moving averages, Fibonacci retracement tools, support, lines, resistance lines, trendlines, round numbers, Bollinger Band indicators, and many others. What you choose to use is purely a personal choice, but there are some very common trading systems that are based upon pullbacks that I have found useful over the years.

Fibonacci retracement

One of the most common ways to play a pullback is to use a Fibonacci retracement tool on a trend. There are a handful of Fibonacci levels that seem to be more important to most traders, with the 50% and the 61.8% Fibonacci retracement level being the most desirable, perhaps followed by the 38.2% Fibonacci retracement level.

On the attached chart, you can see that the AUD/NZD pair fell from the 1.0880 region down to the 1.08 area. It bounced back towards the 1.0850 level, an area that I have a yellow circle drawn, right at the 50% Fibonacci retracement level. Sellers reentered on this pullback and continued to push lower.

Trendlines

Using a simple trend line can be an excellent way to play pullbacks as well. A well-defined trend line that lasts for several candles is a way to play the market, because so many other people are paying attention to the same thing. A trend line by its very definition defines the trend, thereby the directionality, that you should be following. On the attached AUD/CAD chart, you can see clearly that every time we bounced towards the red downtrend line, sellers came in and push the Australian dollar lower against the Canadian dollar. For several months this has been “easy money.”

Moving averages

Moving averages can be one of the easiest ways to play a pullback strategy, but you should make sure you are using a moving average that people care about. On the daily chart, the most important moving average is probably the 200 day moving average, as it shows the longer-term trend. This is the moving average over the last calendar year, which of course carries a bit of weight. There are other moving averages that are important as well, including the 20 EMA, 50 EMA, and the 100 EMA.

On the attached chart, you can see that the EUR/NZD pair had rallied significantly over the course of about five months, before selling off drastically. However, I have the 200 day EMA plotted on the chart, and you can see that the candlestick is starting to form a hammer, which is a bullish sign. Beyond that, there is a cluster of trading action in this vicinity from the month of July, so there’s a good chance there’s buying pressure just waiting to be released in this area.

Support and resistance

The most basic, and probably the most important type of pullback system is built around simple support and resistance. A basic horizontal support or resistance line can make a huge difference in how you view a marketplace. Most of the time, you will see major support and resistance at large, round whole numbers. For example, on the attached USD/ZAR daily chart, you can clearly see that there has been both support and resistance at the 14 handle. This large, round whole number will attract a lot of order flow, and large trading. You can see that we have rallied significantly for some time but have come back to the 14 handle multiple times and have found buyers every time we have. Because of this, you can see just how powerful this type of trading can be. As a side note, you can also see that the 13 handle acted the same way as well.

Hundreds of varieties

The idea of this article wasn’t to give you the “one-size-fits-all” trading strategy that many others will. It was more or less an attempt to open your eyes to the various possibilities that can form a good pullback strategy. In fact, I encourage you to try all of these on a demo account and see what works out the best for you.

It should be noted that these, like almost anything else technical analysis related, work better on the higher time frames. Some of you will find trendlines to your liking, while some of you will like using Fibonacci. But here’s a better question: “have you ever thought about using multiple tools?” The best traders I know will be able to use all of these interchangeably, recognizing that they are all crucial and the more of these that line up in the same direction, the better off you are with your trading results. Why trade for one single reason when you can trade for three or four? Remember, you need to have other people pushing in the same direction you are in order to profit. The more obvious a setup is, the more likely it is that you are going to have enough people out there driving the trade in your direction. In fact, some of the best traders I know can’t be bothered taking a trade unless there’s at least three reasons to do so, and even then they considered to be a lackluster opportunity as opposed to the ones that light up for, five, or even six different reasons.

Find the right combination for you in demo trading, and then apply as many as needed with your live account. You’ll be glad you did, because pullback trading is essentially buying a currency when it’s “on sale.”

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Top 10 most volatile currency pairs and how to trade them

FX markets are susceptible to a range of factors which affect their volatility, and many traders look to tailor their strategies to capitalize on the most volatile currency pairs.

Volatility, usually measured using the standard deviation or variance of a currency, gives traders an expectation of how much a currency can deviate from its current price over a certain period. The higher the volatility of the currency, the higher the risk. Volatility and risk are usually used as interchangeable terms.

Different currency pairs have different volatilities. The major currency pairs like the EUR/USD, USD/JPY, GBP/USD and USD/CHF generally have less volatility than the emerging market currency pairs like the USD/ZAR, USD/KRW and USD/BRL. Normally, more liquid currency pairs have less volatility.

Some traders enjoy the higher potential rewards that come with trading volatile currency pairs, although this increased potential reward comes with a higher risk, so traders should reduce their position sizes when trading highly volatile currency pairs.

What are the most volatile currency pairs?

Top 10 Most volatile currency pairs

Source: Bloomberg Data, Historical volatility, Standard deviation over 10 years of lognormal returns

Among the major currency pairs, the AUD/JPY, NZD/JPY and AUD/USD are currently the most volatile.

Source: Bloomberg Data, Historical volatility, Standard deviation over 10 years of lognormal returns

The USD/ZAR, USD/KRW, USD/BRL and other emerging market currencies pairs tend to be highly volatile due to their low liquidity and because of the risk that is inherent in emerging market economies.

Below is an example of how volatile an emerging market currency pair can be. The USD/ZAR (US Dollar/South Africa Rand) moved 25% in a month and a half. Other emerging market currency pairs have also been seen to make these drastic moves.

What about the least volatile currency pairs?

The least volatile currency pairs tend to be the major currency pairs which are also the most liquid. Also, these economies tend to be larger and more developed which brings more trading volume to their currencies creating a tendency for more price stability.

The EUR/GBP, NZD/USD, USD/CHF and EUR/USD are the least volatile currency pairs. They are the least volatile because they trade with high volumes of liquidity.

As shown below, the USD/CHF’s average true range (ATR) ranges between 90 to 50 pips, a low average true range compared to other pairs. The average true range of a currency is one of the many ways to measure the volatility of a currency pair.

Correlation between two currencies can also lead to lower volatility. For example, the US dollar and Swiss Franc (USD/CHF) are both known as safe-haven currencies (as well as the Japanese Yen) – when risk enters the market, traders flock to these currencies. Both the US dollar and the Swiss Franc strengthen relative to other currencies but do not deviate significantly from each other, and hence the currency pair does not experience as much volatility.

How to trade currency pair volatility

Forex traders should take current volatility and potential changes in volatility into account when trading. Traders should also adjust their position sizes with respect to how volatile a currency pair is. The more volatile a currency pair, the smaller the position the trader should take.

To trade volatile currency pairs, you should understand the differences between volatile currencies and currencies with low volatilities, you should also know how to measure volatility and be aware of events that could create volatility.

The difference between trading currency pairs with high volatility versus low volatility

1. Currencies with high volatility will normally move more pips over a certain period than currencies with low volatility. This leads to an increased risk when trading currency pairs with high volatility.
2. Currencies with high volatility are more prone to slippage than currency pairs with low volatility.
3. Due to high-volatility currency pairs making bigger moves, you should determine the correct position size to take when trading them.

There are several ways to measure volatility

To determine the correct position size, traders need to have an expectation of how volatile a currency can be. A variety of indicators can be used to measure volatility like:

Read our guide to Trading Volatile Markets to find out more about volatility – how it is measured, and how it applies to other markets.

Key things traders should know about volatility:

• Big news events like Brexit or Trade wars can have a major impact on a currency’s volatility. Data releases can also influence volatility. Traders can stay ahead of data releases by using an economic calendar.
• Volatile currency pairs still obey many technical aspects of trading, like support and resistance levels, trendlines and price patterns. Traders can take advantage of the volatility using technical analysis in combination with strict risk management principles.
• Staying up to date with the latest forex pair news, analysis and prices can help you predict possible changes in volatility. At DailyFX we also have comprehensive forex forecasts to help you navigate the market.
• DailyFX hosts daily webinars which can help you prepare for volatile market times.
• Supplement your forex learning and strategy development with our New to Forex guide. This explains in detail the different aspects of forex trading, from bid/ask quotes to margin and short selling.

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Telegram Raises Largest Ever ICO

Telegram, the developers of the popular and notorious encrypted messenger application, have made initial coin offering history with their very successful and ongoing ICO, which has already raised $850 million from corporate subscribers. On the heels of this historic event, we are examining this largest-ever initial coin offering and asking why it has been so popular, and whether it suggests that the field of cryptocurrency ICOs is maturing.

Why are Initial Coin Offerings So Popular?

Cryptocurrencies burst into public consciousness in 2017, with the exponential rise in prices of the major cryptocurrencies fueling a frenzied, speculative bubble. It was not only the major cryptocurrencies which benefited from enormous price increases – investors looking to buy cheap and get in at the ground floor of the next “big thing” sought out smaller, newer cryptocurrencies. Many of these new cryptocurrencies were capitalized through crowdfunding, whereby funders receive initial “coin” in the new cryptocurrency in return for financing it with legal tender fiat currency. The term “ICO” (initial coin offering) was “coined” to reflect the experience of an “initial public offering” by which a hot, newly public company offers its shares which typically then trade at a premium as soon as they hit the market. Speculators and investors have been eager to cash in on new cryptocurrencies in the same way many were happy to get their hands on new public shares of technology companies in the 1990s, or newly privatized utilities in the U.K. during the 1980s. It is against this background that Telegram recently completed the largest ever ICO for their new, currently unnamed cryptocurrency.

The Source of Admiration for Telegram

Telegram is a non-profit, cloud based instant messaging service, founded in 2013 by Pavel Durov. It has made a name for itself, as compared to similar technology applications, in the same way that Bitcoin made a name for itself against fiat currencies such as the U.S. Dollar. If that seems like a strange comparison, here is why I make it: Telegram is open-source, transparent, democratic, non-profit, and above all else, confidential. Telegram has positioned itself on the edge of a very live political debate – whether individuals will be able to enjoy digital privacy, free from spying eyes. Other communication apps such as Facebook or Twitter exist to make money, and they pander to corporate and government interests while taking the data of their users for free. On Telegram’s site, the FAQs include the following statement, which has come to be politically extraordinary in 2018:

Telegram is confidential, free, not-for-profit, and refuses to monetize its users’ data. This is incredible and politically revolutionary. Its emphasis on secure encryption, refusal to share data, and a refusal to be held responsible for nefarious uses of its technology stands out, and has something of the scent of cryptocurrencies and WikiLeaks: an anarchic, decentralized, technologically driven people power that sticks up its middle finger to the Man. Bitcoin is lauded by its ideologically-driven libertarian proponents as doing the same thing to central banks’ abilities to debase and manipulate the money supply. They all stand for creating fair platforms that cannot be gamed by elites and are part of the modern tech zeitgeist.

Leaving politics and fashion to one side, what about the business case for Telegram? It has been hugely successful, becoming a brand of choice for users requiring secure and confidential free digital communication. It is seen as one of the few emerging tech companies that truly has the “space” to build its own digital currency which will have a genuine market for genuine users of the currency, rather than being primarily a speculative venture. This is the major reason why Telegram’s ongoing ICO has been not only unique but the largest and most successful ICO to date.

Telegram’s Biggest-Ever ICO

In February 2018, Telegram raised a record $850 million in an ICO which for the first stage was open only to venture capital firms and corporate investors. Telegram is the first “unicorn” (Silicon Valley terminology for a start-up company valued at more than $1 billion U.S., typically in the software or technology sector) to hold an ICO. Telegram can boast an impressive list of investors from this round, such as Sequoia Capital and Kleiner Perkins Caufield & Byers. When retail investors from the public are invited to apply for the new tokens, they will pay a much higher price. The ICO is a big psychological boost for fans of crypto, who see it as a sign that the field is maturing and that slowly, regulators and titans of the financial system will begin to accept crypto and become part of the ICO ecosystem. If this happens, the kind of “arbitrage” advantage that corporate investors enjoy will become regulated away.

Telegram plans to use the $850 million raised to cover the development of its TON blockchain, as well as for the ongoing development and maintenance costs of its Messenger application. While Telegram boasts on its website that it still has money gifted to it by its CEO Pavel Durov, its finances will have received a strong boost. Telegram is hoping to raise an additional $350 million from the public stage of the ICO.

There are reports that GRAM, the name of Telegram’s soon to be launched cryptocurrency, is already changing hands at a premium before the public ICO has even begun, even though some institutional investors passed on participation. Industry analysts tend to attribute this more to fears over Telegram’s reputation as a useful tool for criminals and terrorists, which gives rise to worries that governments will eventually regulate away its confidentiality.

Conclusion

Every time regulators, central bankers, and tech giants lay into cryptocurrency as a worthless Ponzi scheme, it seems that a glimmer of hope for crypto enthusiasts emerges. Google have just announced that they will no longer accept advertising for ICOs. Yet an ICO done right, such as Telegram’s, points the way to a future where tech environments with a genuine need for their own unit of transaction will be able to successfully launch their own cryptocurrencies.

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ESMA Regulations – Forex, CFD & Binary

The European Union has published new regulations applying to retail Forex, CFD, and the few remaining binary options brokerages in its territory. If you have an account with one such brokerage, the regulations will affect you when they come into force during the late spring and summer. This article will outline how the new regulations will impact your bottom line.

Details of the New ESMA Regulations

In March 2018, the European Securities and Markets Authority (ESMA), the financial regulator and supervisor of the European Union, announced new regulations concerning the provision of contracts for differences (CFDs) and binary options to retail investors. It is unclear exactly when the regulations will come into force, but some time in May or June 2018 looks to be the most likely date, and Forex and CFD brokerages located within the European Union (including the United Kingdom, for the time being) will be forced to comply. The regulations will need to be renewed by ESMA every three months to remain in force over the long term.

The regulation concerning binary options is very simple: they may not be sold. In simple terms, this is the end of binary options as a product sold from within the European Union.

The regulations concerning CFDs are more complex but still relatively straightforward. Firstly, there is some confusion as to what exactly is a CFD, with many traders thinking that spot Forex is not considered a CFD and will therefore be exempt from the new regulations. They are wrong: spot Forex is technically defined as a CFD. In fact, every asset you see available for trading at Forex / CFD brokers will most likely be subject to the new regulations.

The new regulations will implement the following changes for retail client accounts (more on who is a “retail client” later).

• The maximum leverage which can be offered will be 30 to 1. That will apply to major currency pairs such as EUR/USD, GBP/USD, USD/JPY, etc.

• Other currency pairs, major equity indices, and gold will be subject to a maximum leverage of 20 to 1.

• Individual equities cannot be offered with leverage greater than 5 to 1.

• Cryptocurrencies are subject to a maximum leverage of 2 to 1.

• Brokers will be required to provide negative balance protection, meaning it will be impossible to lose more money than you deposit.

• Brokers will be required to close a client’s open positions when the account equity reaches 50% of the required minimum margin by all open positions. This “margin call” provision can be tricky to understand, so will be explained in more detail later.

• Bonuses or any other form of trading incentives may not be offered.

• Brokers will be required to display a standardized risk warning which will include the percentage of their clients who lose money over a defined period.

Understanding the “Margin Call” Regulation

The best way to understand the 50% margin call provision is to use an example. Imagine a client opens an account with a Forex broker, depositing €100 in total. The client opens a short trade in EUR/USD, by going short one mini-lot (one tenth of a full lot). One full lot of EUR/USD is worth €10,000, meaning one mini-lot is worth €1,000. To find out the minimum margin required to support that trade, we divide the size of the trade (€1,000) by 30, which comes to €33.33. This is the minimum required margin to maintain the trade. Half of that amount is €16.67. Now assume the trade goes against the client, with the price of EUR/USD rising above the entry price. As soon as the price rises far enough to produce a floating loss of €83.33 (€100 – €16.67), the broker must close the trade out, even if the trade has no stop loss or has not yet reached the stop loss. In theory, this means that a client’s account can never reach zero. Examples involving multiple open trades will be more complex, but will operate according to the same principles.

What Will This Mean for Traders?

The regulations will only apply to “retail clients”, so you might try to apply to be classed as a professional trader. To get a broker to classify you as anything other than a retail client, you will have to show you have financial qualifications, a large amount of liquid assets, plenty of experience trading, and usually that you also trade frequently. Most traders will be unable to qualify, although it is worth noting that one London-based brokerage, IG Group, has stated that their proportion of clients now classified as “professional” has recently increased from 5% to 15% of their total customers.

The major impact these regulations will have on traders is simple – the maximum trade size they can possibly make at brokers regulated in the European Union will shrink. Many will say that the maximum leverage limits still offer far more than any trader could need, and I agree. I am wary of leverage and I hate to see anyone using leverage greater than 3 to 1 for Forex under any conditions, or any leverage at all for stocks and cryptocurrencies. Commodities can also fluctuate wildly in value. Too many people forget that the biggest danger in leverage is not overly large position sizing, it is that a “black swan” event such as the CHF flash crash of 2015 could happen and wipe out your account through huge price slippage. However, there is another factor that is widely forgotten: why assume that a trader’s account at one Forex broker is all the money they have in the world? For example, a trader might have $10,000 in the bank. If they deposit $1,000 at a broker offering maximum leverage of 300 to 1, they can trade up to $300,000. At a leverage limit of 30 to 1, that trader will have to deposit their entire $10,000 fund to trade at the same size. In a real sense, that trader might now have to take on more risk to operate in the same way, because if the broker goes bust, while beforehand they might lose $1,000 now they could lose $10,000! Even without negative balance protection, that broker would still have to come after them to try to get an extra $9,000 which they theoretically risk. Yet we saw after the CHF crash that brokers don’t come after every single client whose losses exceeded their deposit, due to legal costs and reputational issues. This shows that although the stated purpose of the regulation is to protect traders from excessive losses, the story is not as simple as you may think.

Beyond having to deposit more margin, and automatic margin calls, the other major change for traders will be that they will enjoy negative balance protection. This is a positive development which hopefully will make brokerages focus more heavily on the risks they are taking with their business model in the market. At the same time, a possible side effect of the new regulation is the potential increase in average deposits, leading to brokerages being more stable and better capitalized with client funds. Two final notes: brokerages will have to report on their websites the percentages of clients who are losing and making money, although the period over which the statistics must refer to is currently not clear. This will help to shed light on the debate over what percentage of retail traders are profitable, although some brokerages have already released what they claim to be accurate statistics showing that clients with larger account sizes tend to perform better as traders. Additionally, bonuses and promotions will be banned. I welcome this, as not only do they trivialize the serious business of trading, they are almost always a trick offering the illusion of free money whilst preventing traders from withdrawing any profits until a large number of trades are made (read the fine print the next time you see a broker offering a “bonus”).

What If You’re Not Happy Remaining in the EU?

Traders with accounts at affected brokers who cannot obtain professional status classification and feel they really need higher leverage than the ESMA limits outlined above might look for a solution by opening accounts with brokers outside the European Union. The most obvious destination would be Australia or New Zealand, where it will still be possible to find reasonably well-regulated Forex brokerages offering leverage in the range of 400 to 1. A recent development that is not talked about much is the growing difficulty of transferring funds to and from Forex brokerages in less tightly regulated jurisdictions. You might decide to open an account with a brokerage in Vanuatu, but you may find that a bank within the European Union might just refuse to send your money there for a deposit. This means that going far offshore, depending upon where you live, may not be a feasible option. In any case, the new regulations shouldn’t be impossible to live with, and overall there is a compelling case that they are a net benefit to any trader, so why migrate?

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How to Use Average Pip Movement

What is Average Pip Movement?

Average pip movement is simply the average amount of pips by which the price of a Forex currency pair or cross moves in a given amount of time. It is represented by the Average True Range indicator which shows the average pip movement over whatever length of time it is set to. For example, if the Average True Range indicator is set to 20, and applied to a daily chart, the amount shown by the indicator will represent the average daily pip movement over the past 20 days. There is no reason why this indicator cannot be usefully applied to any other time frame, from the 1 minute to the 1-month charts. This indicator tends to be overlooked by less experienced traders, which is unfortunate, because it can be usefully applied to pick both trade entries and trade exits, as well as to select which currency pairs to trade.

To explain why average pip movement (also called “volatility”) is so useful, we must understand why there is an edge in volatility studies, and what that edge is.

Volatility Statistics

Just as studies of the directional movement of historical prices can indicate the more likely future direction movement by identifying trends or deviations from averages, so can studies of historical volatility indicate the most probable level of future volatility. Academic studies of volatility have shown that the level of volatility tomorrow is likely to be close to the level of volatility today.

Proof of this proposition, that volatility over a current period follows the previous period, can be proven by a back test on some major Forex currency pairs using thousands of samples over almost two decades of historical data:

Currency Pair	% Days Volatility >50% or <100% Previous Day
EUR/USD	68.12%
GBP/USD	70.12%
USD/JPY	68.21%
ALL	68.82%

This shows that slightly more than two-thirds of days have ranged within half or 100% of the volatility of the previous day. In plainer terms, if yesterday’s pip movement was 100 pips, there is probably a 48% chance that today’s pip range will be between 50 and 100 pips. A “clustering” effect exists, even if you only use a single previous period to measure the effect. If you use a wider look-back, say the Average True Range (ATR) of the previous 20 days, the clustering tightens a little further:

Currency Pair	% Days Volatility >50% <100% ATR 20 Day
EUR/USD	72.63%
GBP/USD	73.37%
USD/JPY	70.88%
ALL	72.29%

How to Use Volatility to Choose Trade Entries

As we have seen that likely future volatility can be inferred from current volatility, using an increase in volatility above the average pip movement as an entry trigger can improve your trading profitability, because it suggests that there is likely to be greater movement in price. For example, let’s say you are looking to trade the GBP/USD currency pair long on the H4 time frame, and the ATR 30 shows that the average pip movement over 4 hours is 30 pips. You then get a candle moving in the direction that you want to trade in which has a range of 40 pips, and the candle’s high breaks quickly. This tells you that it could be a better than usual time to enter a trade, because the price is showing unusually strong momentum in the direction that you want it to go. Volatility can be used in this way to measure momentum. Of course, the potential disadvantage is that the further the price has already moved before you enter, the higher the chance that the move has already mostly played out. Yet if you wait for average pip movement to be around, say, 25% higher than normal before entering, it will put the odds more firmly in your favor when used on less liquid major currencies such as the British Pound and the Japanese Yen. Remember also that if you see volatility just beginning to move beyond its average, it is likely to continue to be relatively high, which should also be good news for your trade as it can mean the price will go in your favor relatively strongly and quickly. With the extremely liquid EUR/USD currency pair EUR/USD, interestingly, waiting for volatility to be relatively low works better in picking trade entries.

Another possible technique to apply is waiting for a very strong and fast dip in a trend – a highly volatile movement – to turn back in the direction of the trend, and then entering. This is a high-probability set-up because of two factors: the probability of the trend to continue in its trending direction, and the probability that the volatility will remain high. Taken together, it means that the price is more likely than not to snap back quickly in the direction of the trend. I have published a back test based on this method using the three major Forex pairs, which showed very strongly positive results.

So far, this is an explanation of picking trade entries which focuses upon the price at and just before the time of entry, but there is a wider context to consider. The currency pair that is showing the highest volatility today is likely to be the biggest mover tomorrow, so it might be a wise idea to put your focus there at the start of the next trading day. Also, how about using volatility to decide whether to take what looks like being a good trade entry? Remember that if it is early in the trading day and 80% of the average pip movement for the day has already been made, and you are trading in the direction of the movement, your entry is going to be too late most of the time. For example, if the 20-day Average True Range is 100 pips, and the price was 1.0000 at Midnight and is 1.0090 at 11am, if you enter a long trade then in most cases it won’t advance further enough to make the trade much of a winner. However, on a few occasions it will go much further, but the best trades will usually be the ones which set up before the average range is made.

How to Use Volatility to Choose Trade Exits

The good news is that average pip movement can be used in several ways to optimize your trade exits, as well as your trade entries.

The most common exit method using volatility is used by day traders, who might keep an eye on the Average True Range indicator on a daily chart applied to whatever they are trading. They often look to exit when the pip movement made for the day is approximately equal to the ATR 20. This can be a great method for day traders, especially when the volatility value is close to the location of major support and resistance and maybe a round number as well. However, there is a common pitfall here. What is usually not understood is that most days, the pip movement does not equal its average pip movement – but on the days when traders can really make a lot of money, the price will exceed that value! This means that if you are aiming for a conservative profit target, you should be watching for something like 80% of the 20-day ATR. This is because on average only 51% of days reach the value of the 20-day ATR. The problem is that you will get a few days where the price just keeps going and going, and by letting these winners run, you can make your trading more profitable. The answer to this dilemma is to watch what the price does as it gets beyond more than 80% of the average daily pip movement. If the price action starts to go flat and you see short-term volatility decreasing, this would suggest that the trade does not have any more profit left in it, at least over the short-term. Alternatively, if the price just keeps going in your direction like a train, stay in the trade and expect a day of abnormally large pip movement to play out.

Finally, if you are in trade and the price is moving in your favor, and then it starts to move against you with much larger candlestick pip ranges than the advance was showing, it is usually a good signal that it is time to get out of the trade, at least over the short-term, because it is probably going to move even further against you.

Conclusion

Average pip movement is a very useful but often overlooked tool that can be applied easily using the Average True Range Indicator. It can be used to determine:

• Which currency pair(s) or cross(es) are worth trading

• Whether it is probably too late to find a high-probability trade entry

• When a good entry opportunity has come

• When to exit a profitable trade

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