TECHNICAL TRADING STRATEGIES

TECHNICAL TRADING
STRATEGIES




MULTIPLE TIME FRAME ANALYSIS
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In order to trade successfully on an intraday basis, it is important to be selective. Trend trading is one of the most popular strategies employed by global macro hedge funds. Although there are many traders who prefer to range trade, the big profit potentials tend to lie in trades that capture and participate in big market movements. It was once said by Mark Boucher, a hedge fund manager of Midas Trust Fund and a former number one money manager as ranked by Nelson MarketPlace’s World’s Best Money Managers, that 70 percent of a market’s moves occurs 20 percent of the time. This makes multiple time frame analysis particularly important because no trader wants to lose sight of the overall big picture. A great comparison is taking a road trip from Chicago to Florida. There are certainly going to be a lot of left and right turns during the road trip, but the driver needs to be aware throughout the whole trip that he or she is headed south. In trading, looking for opportunities to buy in an uptrend or sell in a downtrend tends to be much more profitable than trying to pick tops and bottoms.

The most common form of multiple time frame analysis is to use daily charts to identify the overall trend and then to use the hourly charts to determine specific entry levels.

The AUD/USD chart is a daily chart of the Australian dollar against the U.S. dollar. As you can see, the Australian dollar has been trending higher since January 2002. Range or contrarian traders who continually looked to pick tops would have been faced with at

FIGURE AUD/USD Multiple Time Frame Daily Chart

least three years of unprofitable and difficult trading, particularly when the currency pair was hitting record highs in late 2003 into early 2004. This area would have certainly attracted many traders looking to pick a top or to fade the trend. Despite a dip in late 2004, the AUD/USD has remained strong going into 2005, which would have made it very difficult for medium-term range players to trade.

Instead, the more effective trading strategy is to actually take a position in the direction of the trend. In the AUD/USD example, this would have involved looking for opportunities to buy on dips. Rather than looking for opportunities to sell, we use the 76 percent Fibonacci retracement level as key support zones to go long the Australian dollar. What we did therefore was use the daily charts to get a gauge of the overall trend and then used the hourly charts to pinpoint entry levels.

Let’s take a look at another example, this one of the British pound. Like traders of the Australian dollar, traders trying to pick tops in the GBP/USD would have also faced at least three years of difficult trading, particularly when the GBP/USD was making 10-year highs 
FIGURE  AUD/USD Multiple Time Frame Hourly Chart

FIGURE  GBP/USD Multiple Time Frame Daily Chart

in January 2004. This level would have certainly attracted many skeptics looking to pick tops. To the frustration of those who did, the GBP/USD rallied up to 10 percent beyond its 10-year highs post January, which means that those top pickers would have incurred significant losses.

Taking a look at the hourly chart for the GBP/USD, we want to look for opportunities to buy on dips rather than sell on rallies. Shows two Fibonacci retracement levels drawn from the September 2004 and December 2004 bull wave. Those levels held pretty well on retracements between four-tenths and four-fourteenths while the 23.6 percent Fibonacci level offered an opportunity for breakout trading rather than a significant resistance level. In that particular scenario, keeping in mind the bigger picture would have shielded traders from trying to engage in reversal plays at those levels.

Multiple time frame analysis can also be employed on a shorter-term basis. Let us take a look at an example using CHF/JPY. First we start with our hourly chart of CHF/JPY. Using Fibonacci retracements, we see on our hourly charts that prices have failed at the 38.2 percent retracement of the December 30, 2004, to February 9, 2005, bear wave numerous times. This indicates that the pair is contained within a weeklong downtrend below those levels. Therefore, we want to use our 15-minute charts to look for entry levels to participate 
FIGURE  GBP/USDMultiple Time Frame Hourly Chart

FIGURE  CHF/JPY Multiple Time Frame Hourly Chart

in the overall downtrend. However, in order to increase the success of this trade, we want to make sure that CHF/JPY is also in a downtrend on a daily basis.

We see that CHF/JPY is indeed trading below the 200-day simple moving average with the 20-day SMA crossing below the 100-day SMA. This confirms the bearish momentum in the currency pair. So as a day trader, we move on to the 15-minute chart to pinpoint entry levels. The 15-minute chart; the horizontal line is the 38.2 percent Fibonacci retracement of the earlier downtrend. We see that CHF/JPY broke above the horizontal line on May 11, 2005; however, rather than buying into a potential breakout trade, the bearish big picture reflected on the hourly and daily charts suggests a contrarian trade at this point. In fact, there were two instances where the currency pair broke above the Fibonacci level only to then trade significantly lower. Disciplined day traders would use those opportunities to fade the breakout.

The importance of multiple time frame analysis cannot be overestimated. Thinking about the big picture first will keep traders out of numerous dangerous trades. The majority of new traders in the market are range traders for the simple fact that buying at the low and selling at the high is an easy concept to grasp. Of course, this strategy does work, but traders also need to be mindful of the trading environment that they are
FIGURE  CHF/JPY Multiple Time Frame Daily Chart

FIGURE  CHF/JPY Multiple Time Frame 15-Minute Chart

participating in the conditions for a range-bound market are met. The most important condition (but certainly not the only one) is to look for ADX to be less than 25 and ideally trending downward.

FADING THE DOUBLE ZEROS
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One of the most widely overlooked yet lucrative areas of trading is market structure. Developing a keen understanding of micro structure and dynamics allows traders to gain an unbelievable advantage and is probably one of the most reliable tactics for profiting from intraday fluctuations. Developing a feel for and understanding of market dynamics is key to profitably taking advantage of short-term fluctuations. In foreign exchange trading this is especially critical, as the primary influence of intraday price action is order flow. Given the fact that most individual traders are not privy to sell-side bank order flow, day traders looking to profit from short-term fluctuations need to learn how to identify and anticipate price zones where large order flows should be triggered. This technique is very efficient for intraday traders as it allows them to get on the same side as the market maker.

When trading intraday, it is impossible to look for bounces off of every support or resistance level and expect to be profitable. The key to successful intraday trading requires that we be more selective and enter only at those levels where a reaction is more likely. Trading off psychologically important levels such as the double zeros or round numbers is one good way of identifying such opportunities. Double zeros represent numbers where the last two digits are zeros—for example, 107.00 in the USD/JPY or 1.2800 in the EUR/USD. After noticing how many times a currency pair would bounce off of double zero support or resistance levels intraday despite the underlying trend, we have noticed that the bounces are usually much bigger and more relevant than rallies off other areas. This type of reaction is perfect for intraday FX traders as it gives them the opportunity to make 50 pips while risking only 15 to 20 pips.

Implementing this methodology is not difficult, but it does require individual traders to develop a solid feel for dealing room and market participant psychology. The idea behind why this methodology works is simple. Large banks with access to conditional order flow have a very distinct advantage over other market participants. The banks’ order books give them direct insight into potential reactions at different price levels. Dealers will often use this strategic information themselves to put on short-term positions for their own accounts.

Market participants as a whole tend to put conditional orders near or around the same levels. While stop-loss orders are usually placed just beyond the round numbers, traders will cluster their take-profit orders at the round number. The reason why this occurs is because traders are humans and humans tend to think in round numbers. As a result, take-profit orders have a very high tendency of being placed at the double zero level. Since the FX market is a nonstop continuous market, speculators also use stop and limit orders much more frequently than in other markets. Large banks with access to conditional order flow, like stops and limits, actively seek to exploit these clusterings of positions to basically gun stops. The strategy of fading the double zeros attempts to put traders on the same side as market makers and basically positions traders for a quick contra-trend move at the double zero level.

This trade is most profitable when there are other technical indicators that confirm the significance of the double zero level.

Strategy Rules

Long

  1. First, locate a currency pair that is trading well below its intraday 20-period simple moving average on a 10- or 15-minute chart.
  2. Next, enter a long position several pips below the figure (no more than 10).
  3. Place an initial protective stop no more than 20 pips below the entry price.
  4. When the position is profitable by double the amount that you risked, close half of the position and move your stop on the remaining portion of the trade to breakeven. Trail your stop as the price moves in your favor.


Short

  1. First, locate a currency pair that is trading well above its intraday 20-period simple moving average on a 10- or 15-minute chart.
  2. Next, short the currency pair several pips above the figure (no more than 10).
  3. Place an initial protective stop no more than 20 pips above the entry price.
  4. When the position is profitable by double the amount that you risked, close half of the position and move your stop on the remaining portion of the trade to breakeven. Trail your stop as the price moves in your favor. 


Market Conditions

This strategy works best when the move happens without any major economic number as a catalyst—in other words, in quieter market conditions. It is used most successfully for pairs with tighter trading ranges, crosses, and commodity currencies. This strategy does work for the majors but under quieter market conditions since the stops are relatively tight.

Further Optimization

The psychologically important round number levels have even greater significance if they coincide with a key technical level. Therefore the strategy tends to have an even higher probability of success when other important support or resistance levels converge at the figure, such as moving averages, key Fibonacci levels, and Bollinger bands, just to name a few.

Examples

So let us take a look at some of the examples of this strategy in action. The first example that we will go over, a 15-minute chart of the EUR/USD. According to the rules of the strategy, we see that the EUR/USD broke down and was trading well below its 20-period moving average. Prices continued to trend lower, moving toward 1.2800, which is
FIGURE  EUR/USD Double Zeros Example

our double zero number. In accordance with the rules, we place an entry order a few pips below the breakeven number at 1.2795. Our order is triggered and we put our stop 20 pips away at 1.2775. The currency pair hits a low of 1.2786 before moving higher. We then sell half of the position when the currency pair rallies by double the amount that we risked at 1.2835. The stop on the remaining half of the position is then moved to breakeven at 1.2795. We proceed to trail the stop. The trailing stop can be done using a variety of methods including a monetary or percentage basis. We choose to trail the stop by a two-bar low for a really short-term trade and end up getting out of the other half of the position at 1.2831. Therefore on this trade we earned 40 pips on the first position and 36 pips on the second position.

The next example is for USD/JPY. we see that USD/JPY is trading well below its 20-period moving average on a 10-minute chart and is headed toward the 105 double zero level. This trade is particularly strong because the 105 level is very important in USD/JPY. Not only is it a psychologically important level, but it also served as an important support and resistance level throughout 2004 and into early 2005. The 105 level is also the 23.6 percent Fibonacci retracement of the May 14, 2004, high and January 17, 2005, low. All of this provides a strong signal that lots of speculators may have taken profit orders at that level and that a contra-trend trade is very likely. As a result, we place our limit order a few pips below 105.00 at 104.95. The trade is triggered and we place our stop at 104.75.
FIGURE  USD/JPY Double Zeros Example

The currency pair hits a low of 104.88 before moving higher. We then sell half of our position when the currency pair rallies by double the amount that we risked at 105.35. The stop on the remaining half of the position is then moved to breakeven at 104.95. We proceed to trail the stop by a fivebar low to filter out noise on the shorter time frame. We end up selling the other half of the position at 105.71. As a result on this trade, we earned 40 pips on the first position and 76 pips on the second position. The reason why this second trade was more profitable than the one in the first example is because the double zero level was also a significant technical level.

Making sure that the double zero level is a significant level is a key element of filtering for good trades. The great thing about this trade is that it is a triple zero level rather than just a double zero level. Triple zero levels hold even more significance than double zero levels because of their less frequent occurrence. we see that USD/CAD is also trading well below its 20-period moving average and heading toward 1.2000. We look to go long a few pips below the double zero level at 1.1995. We place our stop 20 pips away at 1.1975. The currency pair hits a low of 1.1980 before moving higher. We then sell half of our position when the currency pair rallies by double the amount that we risked at 1.2035. The stop on the remaining half of the position is then moved to breakeven at 1.1995. We proceed to trail the  stop once again by the two-bar low and end up exiting the second half of the position at 1.2081. As a result, we earned 40 pips on the first position and 86 pips on the second position. Once again, this trade worked particularly well because 1.2000 was a triple zero level. 
FIGURE  USD/CAD Double Zeros

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