02-Forex Price Action Explained-Svetlin Minev

For more FREE Ebooks, strategies and materials you can visit:
http://theultimatetradingedge.com/
or email me at svetlin@theultimatetradingedge.com
TABLE OF CONTENTS
PREFACE
PRICE ACTION BASICS
CHART PATTERNS
STATISTICS AND FOREX
HOW TO READ THE CANDLESTICKS
QUOTE READING
PREFACE
“An investment in knowledge pays the best interest.”
~ Benjamin Franklin
Trading is a zero sum game.

If you are winning someone else is losing and vice versa.
This is the first thing you have to understand about the financial
markets.
If you don't get this you have good chances to join the 95% club of
unsuccessful traders.
The good news is that you can make nice income working from home
just a few hours a day because trading is like any other business.
The other important aspect of the trading is that it is not an art gallery
which means that technical analysis is not all you need to know.
You must learn how markets operate which are the main players and
what they exactly do.
Also you have to learn what market conditions you can trade and
which financial instruments you should use.
To tell the long story short trading is a business and you have to treat
it like that and if you consider treating it like a hobby you’d better do
something more relaxing.
The fact that trading is a zero sum game implies one very important
requirement - you must have an edge if you want to be a successful trader.
This is the reality and you can't change it.
After the 18 years that I’ve spent on the financial markets as an
individual trader, risk manager (during the world financial crisis) and FX
dealer (during the EU debt crisis) I‘ve learned one thing - the ULTIMATE
trading EDGE you need before you name yourself experienced trader is
KNOWLEDGE.
It is not a holy-grail trading system or secret method for analysis.
Financial markets are always changing and if you want to make
money in the long term you must adapt.
And you can't adapt to the new market conditions if you don't have
sufficient knowledge.
You have to know how the markets work, what the large participants
do, what types of instruments you can use, how the fundamentals affect the
prices, etc.
Remember! Knowledge about the markets will pay the highest
interest on your capital.
Bon voyage!
-Svetlin
PRICE ACTION BASICS
The price action trading is a style that is based on naked charts (no
indicators).
Decisions to open and manage the positions are mostly based on chart
patterns, trend lines and levels of support and resistance.
The most positive feature of this method of analysis and trading is
that we trade what actually is going on the market and we are able to react
quickly and appropriately if the situation changes.
Furthermore, you should not try to predict where the price will be, but
rather use the natural mechanics of the market, as reflected on the charts.
The only indicator that is used is the moving average, but it serves
rather as a dynamic trend line or level of support or resistance.
The rules are pretty simple and clear enough regarding the exact
levels for entry and initial protective stop.
Problems can arise only from the discipline of the trader and its
ability to comply with the trading rules, but this is not price action's fault.
Swing high and low
As I wrote in my first book, the bar and candlesticks charts are the
next source of information about what is happening in the forex market after
the quotes.
The price action trading is based on the basic concepts that every
trader knows, but I will remind them to you briefly.
The first thing you need to learn to identify, are the swing highs and
lows.
They are probably the best levels of support and resistance, but they
are used also for drawing of trend lines and price channels.
Swing high occurs when the maximum of the price bar (candlestick)
is above the maximums of the previous and the next two bars (candlesticks).
Swing low occurs when the minimum of the price bar (candlestick) is
below the minimums of the previous and following two bars (candlesticks).
Chart 1 show how the swing high and lows look like.
On Chart 2 you can see them in a real situation.
Swing high and low
Chart 1
Swing high and low
Chart 2
Source: Metaquotes Software Corp.
Trend
Prices of financial instruments can move in one direction (trend) or
sideways (consolidation).
When prices make consistently higher highs and higher lows we have
an uptrend (Chart 3).
When prices are consistently making lower highs and lower lows we
have a downward trend (Chart 4).
If there is no clear trend in the formation of the consecutive highs and
lows, the market is in a consolidation phase (Chart 5).
Uptrend
Chart 3
Downtrend
Chart 4
Consolidation
Chart 5
When you identify that the market is in a trend it is very useful to
draw trend lines and price channels across the swing highs and lows.
At any time multiple trend lines could be drawn and depending on the
price action around them, we can decide whether to enter the market or not.
Standard uptrend line is drawn at the swing lows (Chart 6), while the
downtrend line – across swing highs (Chart 7).
Accordingly, across an opposite extreme (swing high for uptrend or
swing low for downtrend) we draw a parallel line, and form a price channel.
Al Brooks has developed the subject in great detail in his book ‘Price
Action’ and I recommend that you to read it.
Uptrend
Source: MetaQuotes Software Corp.
Chart 6
Downtrend

Chart 7
Support and resistance levels
I want to draw your attention to the content of the next few pages,
where I will explain about the levels of support and resistance levels and why
they are so important to our successful performance in the forex markets.
Correct selection of these levels will enable us more accurately and
more successfully to identify the points at which could be expected reversal
of the price movement.
These points are important to determine our entry and exit levels,
which actually is the essence of trading.
Opening a position in the middle of nowhere can only lead to
unnecessary losses and is closer to gambling, which relies only on pure
probabilities without the analysis of the market sentiment or fundamental
factors.
Your first job in the morning is to draw the closest levels of support
and resistance on the currency pairs that you monitor and trade.
In this way you will have roadmaps to guide you in the market
jungle. Without them, your navigation will be very difficult.
What actually are the levels of support and resistance?
I will not bore you with unnecessary definitions, because their name
says everything there is to say.
Resistance levels are above the current market price and are capping
the upward price movement.
Support levels are below the current market price and are stopping the
downward price moves. In an uptrend, it could be expected that levels of
support to withstand testing and the break will break through resistance
levels.
The opposite is valid for the downtrends - resistance levels easier to
stop the price move, and the levels of support are usually broken.
When a resistance level is penetrated, it usually becomes a support
level and vice versa.
The main reason why we have to know the support and resistance
levels is the fact that market participants usually place their orders around
them.
This is a very important fact and you should always keep it in mind.
Above the levels of support generally are placed buy limit orders to
open long positions or take profits on shorts, while underneath there are sell
stops to limit losses on long positions or open new shorts.
Below the levels of resistance usually are placed sell limit orders to
open short positions or take profits on longs, while above them are clustered
stops to limit losses on short positions or open new longs (Chart 8).
This is a very simple chart, but it says everything that is important for
the forex market structure.
Yes, it is as simple and clear as you see it on Chart 8.
All you have to do is just to follow the big money.
When we learn to properly define these levels, we will open positions
with other market participants, some of them with serious capabilities.
This is exactly the idea of the entire operation. Your position will
develop in one way, if you buy a currency pair at a level around which buy
orders by large Asian sovereign fund are placed and quite differently if you
join the market at a random price level and the nearest level for protective
stop is one account away.
So again I recommend you to study very well how to identify support
and resistance levels, and to open your positions only near them.
Orders around support and resistance levels
Chart 8
Now I will discuss the topic about the most popular support and
resistance levels and how we can use them in our trading.
These are the swing highs and lows, trend lines, moving averages,
pivot points, Fibonacci levels, psychological levels, Bollinger bands.
I want to explain further about the most common support and
resistance levels, and these are the swing high and low.
As I said a swing high occurs when the maximum of the price bar is
above the maximums of the previous and following two bars, while for the
swing low – the minimum of the price bar is below the lowest points of the
previous and the next two bars (Chart 1).
It is important to note that we should look for swing highs and lows
only at the end of a directional price move, and not in the middle of
consolidation.
Now let's see how we can use the swing highs and lows in our trading.
On Chart 9 I showed swing highs and lows for the USD/JPY currency
pair.
In this case, the chart time frame is one hour. You should draw the
support and resistance levels on a time framer which is greater than that one
you use for identifying of entry levels.
For example, if you trade on 5-minute chart, you should draw your
support and resistance levels on 15-minutes or 1-hour charts.
In the example below you can see how the pair has tested the
resistance around 90.54, but the bulls were not strong enough to break this
level.
If we had a sell signal, we could be able to open a short position
directly at the level or to switch to a one-or five-minute charts to look for a
more accurate entry (Chart 10).
Swing highs and lows for USD/JPY

Chart 9
Possible entries for short position

Chart 10
On Chart 10 I have shown how we can use the one minute chart to
trade the test of the previous swing high.
Usually we have two main options for entry. The first one is to sell
during the attack of the resistance 1 pip below the previous swing high.
This is a little more complicated exercise and should be done when
we have accumulated enough experience in quote reading.
In this case, depending on the money and position management rules
we can use stop between 6 and 10 pips.
The stop could be wider if you are looking for long-term price move.
The second option is to wait for a reversal pattern on the one-minute
chart to form.
This could be a reversal candlestick or at least 2-3 consecutive periods
with similar or equal lows.
Then we can sell 1 pip below these minimums, but our initial stop
will be over 10 pips.
In the first case there is a risk that the market will break the resistance
level and hit our protective stop because we do not have confirmation for the
reversal by the price action.
In the second case we have some confirmation by the price action, but
the initial risk of the position is greater.
Nobody can tell you which version is better. You have to decide for
yourself how to determine the exact entry level.
More important is to be consistent and use the same method every
time.
It is trading not gambling.
The trend lines are usually used to show the presence and direction of
a trending price move.
These trend lines could be also used as levels of support and
resistance.
Actually we are interested in the point of the trend line, which is
nearest to the current market quotes.
To draw a trend line it is just enough to identify two swing highs or
lows with different values and draw a straight line across them.
On Chart 11, you can see lots of trend lines of all types and size,
which act as support or resistance.
Not all of the possible trend lines are shown, because it is only an
example, and the idea was to demonstrate the basic principle.
In practice it will be necessary to draw the levels of support and
resistance that are closest to the current market prices and are likely to be
tested throughout the day. However, I leave old lines on my charts, which
sometimes pop up out of nowhere. It is interesting that the price often
complies with them.
There are several interesting cases that are marked on the graph.
I want to draw your attention to the points where a trend line and a
swing high or low coincide.
These levels are very strong, because a larger number of market
participants place their orders around them.
Another interesting point is that after the trend line is broken, usually
the market pulls back to retest and then continues its movement in the new
direction.
These tests provide very good trading opportunities in the direction of
the new price move.
Trend lines as support and resistance levels

Chart 11
Moving averages (MA), are used not only as a method for smoothing
of short-term price fluctuations.
They also are very good of dynamic levels of support and resistance.
Technical analysis has become a self-fulfilling prophecy. So technical
indicators, including the moving averages, have a life of their own and could
be applied in various ways.
For the purposes of the technical analysis could be used different
types of moving averages. They main difference is the weight that is assigned
to the nearest prices.
The simple moving average is calculated with equal weights for all
the prices. For the exponential moving average, the weighting for each older
data point decreases exponentially, never reaching zero.
Quotes of a currency pair are a time series, and one of the simplest
ways to smooth them are the moving averages. They are calculated as
follows.
If you want to calculate for example a five period moving average,
take the first five elements of the time series and calculate their average.
On a daily chart this means the first five closing prices (or daily highs
or lows).
The calculated average is the first element of the new smoothed time
series.
To calculate its second element, we take elements from 2 to 6 of the
original time series and calculate their average.
The same procedure is "moving" until the end of the original time
series of quotes and as a results we have are new moving average time series
(Table 1).
Calculation of a moving average
Table 1
When speaking of moving averages, it always logically arises the

question what type of MA we should use and what period of smoothing.
There is no simple answer, so everyone has to make a set of moving
averages depending on his style of trading.
For this purpose it is necessary to keep in mind that the smaller the
period, the closer the indicator chart will be to that of the currency pair and
will be more sensitive to changes in direction.
On the other hand if we choose a longer time period for the moving
average, smoothing will be greater and the MA will indicate the long-term
trend.
Exponential moving average values depend more on the past price
quotes than that of the simple moving average.
Around the 20-period moving average you can expect orders of short-
term players, while around 200-period MA you can expect orders of long-
term market players.
I personally use the 20, 50, 100 and 200 period exponential moving
averages (Chart 12).
You can read the market comments and see what averages are near
the market at that moment, because bank or hedge fund analysts may use
different periods for smoothing.
Pivot Points
Pivot points were used years ago mainly from the brokers on the
floors of the futures exchange for generating signals for scalping.
Nowadays they have become a popular method for determining the
levels of support and resistance.
Pivot points are calculated as follows:
R3 = H + 2(PP - L)
R2 = PP + (H - L )
R1 = (2 x PP) – L
PP = (H + L + C )
S1 = (2 x PP) – H
S2 = PP - (H - L)
S3 = L - 2(H - PP), where
S – Support level,
R – Resistance level,
PP – Central pivot,
H – previous period's high,
L - previous period's low,
C - previous period's close.
These formulas are provided here for information purposes only and
you don't have to remember them.
There are various custom indicators for MetaTrader (Chart 13) and
other platforms, as well as websites which have pivot point calculators
(http://www.mataf.net/en/tools/pivot-points).
If the currency pair quotes are above the central pivot the market is
bullish.
If the quotes are below the central pivot, the market is bearish.
The support levels are S1, S2 and S3, while the resistance levels are
R1, R2 and R3.
Usually the pivots are calculated using the daily high, low and close,
but are plotted on a lower time frame chart.
For the calculation of the pivot points always arises the question
“what time zone we have to use to determine the daily extremes and closing
price?“.
For the start of the day I use 00:00AM local time (GMT +2 winter
time and GMT +3 DST), because the end of the day coincides with the close
of business in New York.
I've noticed that, when calculated in this way, the pivots are good
levels of support and resistance.
Of course everyone can use any time zone and test if the pivots are
accurate.
Daily pivots plotted on 15-minutes EUR/USD chart

Chart 13
Fibonnacci
Mathematician Leonardo Fibonacci was born in Italy around 1170
and it is believed that he had discovered the sequence that is now called the
Fibonacci (fib) numbers while studying the pyramids of Giza.
He created a series in which each successive number is a sum of the
previous two:
1, 1, 2, 3 , 5, 8, 13, 21 , 34, 55 , 89, 144 , 233 , etc.
This sequence of numbers has many interesting relationships that can
be seen in various fields of science and society.
What you have to remember as a forex trader is that the ratio of any
number to the previous one is 1.618, and to the next – 0.618.
Based on these facts we can derive the following percentages 38.2%,
50% and 61.8%, as well as 23.6% and 76.4%.
The exact calculations I think are not so important and can be made
by anyone who has knowledge of basic math.
The only important thing is that the Fibonacci numbers are used by a
large number of market participants and have become a self-fulfilling
prophecy.
There are four main Fibonacci tools – retracements, arcs, fans and
time extensions.
I would draw your attention only to the first of them.
Fibonacci retracements are used as support and resistance levels and it
could be expected that the price moves will change direction around them.
To calculate the Fibonacci Retracement levels, we must select
significant swing low and significant high.
After these price extremes are selected we can calculate the main
Fibonacci levels 38.2%, 50% and 61.8%, and also 23.6% and 76.4%.
For the new price move could be calculated extrapolation price targets
- 161.8%, 261.8% and 423.6%. It is not necessary to calculate these numbers
yourself, as in any charting software you can find Fibonacci tool.
After significant movement in one direction, prices usually make
correction and the Fibonacci retracements serve as support or resistance.
Around these price levels you can find good entries in the direction of
the current trend with a very favorable risk/reward ratio.
On Chart 14 you can see how after each downward movement of
GBP/USD, follows retracement that almost always ends up at price level
calculated using the Fibonacci numbers.
From my experience I can tell that almost all currency pairs are
making retracements to such levels of support and resistance.
However, there is no absolute happiness and we should not rely 100%
only on Leonardo Fibonacci and his numbers, or to think that the
retracements will stop exactly at the price level.
Note that the market can break through any resistance or support
(hitting stops) just as much as is sufficient to give the impression to continue
its run and then turn suddenly and surprisingly for many traders. About this
you can read more in the first book.
Fibonacci levels

Chart 14
I left my favorite support and resistance levels for dessert.

The round numbers (a.k.a. big figures), are also known as
psychological levels.
These are price levels that end with “00”. For example for the
currency pair EUR/USD round numbers are 1.3900 and 1.4000, while for the
USD/JPY they could be 91.00 or 100.00.
There are various reasons why this kind of support and resistance
really work.
The first is purely psychological, as probably any quotation ending
with '00 works magically to the market participants.
I think that much more important is another very trivial, yet very real
reason.
When planning their budgets for future periods International
companies often use rounded exchange rates.
Because of this fact, the last two digits of the exchange rate simply
are “missing“.
When the company decides to hedge its currency risk using options,
they choose exercise prices that are matching the budgeted exchange rate.
At the options maturity, most companies are hedging the options
Greeks.
This is creating increased demand and supply of the currency pair
around round numbers.
In addition to hedging, options are used for speculatative purposes.
This creates additional market activity around round price levels.
Many large speculators defend barriers or digital options that are also
around round numbers.
In short, almost always around the round numbers are placed orders
of different kinds.
For us it doesn't matter if this is due to purely psychological or other
reasons.
These price levels provide one of the best trading opportunities and
we have to take advantage of this whenever we can.
Much of the Japanese companies have major export and import
business and therefore have foreign exchange risk.
This fact makes them one of the most active foreign exchange
participants that hedge.
Perhaps for this reason, around the round numbers of USD/JPY and
EUR/JPY you can see serious aggregation of orders.
Very rarely USD/JPY can break through a round number on the first
attempt.
On Chart 15 you can see how round numbers acted as support or
resistance for EUR/USD.
Here I would like to note that the price movement does not stop
exactly at 1.4000.
It always ends a pip or two above or below the round number.
In one of my other books I will come back to the round numbers and
show you how to trade them.
Round numbers as support and resistance

Chart 15
After the review of the trendlines and support and resistance levels, I
will give you some practical guidelines for their use for analysis and trading.
Your first job in the morning should be drawing the trend lines and
price channels and determining the closest levels of support and resistance.
I suggest that you limit yourself to a maximum of two price channels
and three levels of support and resistance.
If the market moves more seriously you just have to update the levels.
Strong levels of support and resistance are those that have reversed
the price moves at least two or three times during the last few weeks.
Usually these are price levels around which coincide a couple of
supports and resistances.
For example 1.2300 will be strong support, because this is a round
number, previous swing high (or low) and the 200-period EMA is crossing it.
Weaker support will be 1.3170, because only the 50-period EMA is
there.
If I tell you that, for example moving averages are the most reliable
support and resistance levels, I would lie.
It is easier to have a few hard rules about everything.
Unfortunately, for the forex trading this could be highly misleading
and can actually be fatal.
So do your job correctly by observing the price movement.
Read reviews and analyzes and stuy on your own how to identify the
strongest support and resistance levels.
Over time, you will be able to determine the nearest levels of support
and resistance and which ones are stronger, after only one look at the chart.
However, there is no need to be overconfident.
Moving averages

Chart 15
For the moving averages (MA) is written more than enough.
They are an essential part of my trading strategy, and I will explain
how I use them.
In trading the moving averages are used mainly for determining the
presence and direction of the trend or as dynamic levels of support and
resistance.
To determine the trend we can use a trend line drawn through swing
highs (for downtrend) or swing lows (in an uptrend).
Then we can draw a parallel to the trend line across the opposite
extreme and thus form a price channel.
These lines, however, are static and if you use them you will miss a
lot of price reversals, which are not on the trend lines.
To avoid this disadvantage, it is much better to use dynamic trend
lines such as the moving averages (Chart 16).
They could follow the price depending on the selected period and the
method of averaging and provide more or fewer signals.
The smaller the period of averaging is the faster the moving average
is and the more trading signals it generates.
You should keep in mind that some of them will be false.
Therefore there must be a filter for fine tuning.
The exponential average follows the price movement more closely,
because greater weight is assigned to the most recent prices.
Moving averages and trend channels

Chart 16
Determining the trend with moving averages
You can determine the trend using moving averages very easy, with
the following rules:
When the price is above the moving average, the market is in an
uptrend;
When the price is below the moving average, the market is in an
downtrend;
When the fast MA (the one with the smaller period) is over the slow
MA and both are rising, the trend is up;
When the fast MA is below the slow MA and both are declining, the
trend is down;
The faster the average is the more often it will generate signals for
changes in the direction of the price move.
Most of these signals will be false.
It is advisable to select a period of averaging depending on your
trading style.
When the moving averages are horizontal and are crossing repeatedly,
the market is in a period of consolidation.
Chart 17 shows how you can use the moving averages to determine
the market direction. In my trading I use 20, 50, 100 and 200-period
exponential moving averages (EMA).
For identification and determining the direction of the trend I use the
first two.
It is advisable to determine the trend on a higher time frame and look
for trading signals on a chart with a lower time frame.
The example shows a 15-minute chart of EUR/USD.
For finding of trading signals the 1-minute chart could be used.
Determining the trend with moving averages
Source: MetaQuotes Software Corp

. Chart 17
Types of entries around moving averages

If you want to join a price move earlier than the other traders, you can
use moving averages as dynamic levels of support and resistance.
Thus using only moving averages you can have a trading system that
gives you tools to identify the presence and direction of the trend, as well as
the exact entry and protective stop levels.
Unfortunately you can not expect that every time the price will touch
the moving average that you have chosen and then immediately return in the
direction of the trend.
So you should choose a set of rules to determine the exact level and
timing of the position opening.
It is absolutely necessary to apply the same set of rules whenever we
have an entry signal.
The first and also the most aggressive and most risky option is to buy
or sell exactly when the price touches the average.
In this case it is necessary to use additional filters, since we have no
reason to believe that the test of the MA itself is sufficient and a large market
participant will act the same way.
As additional filters can be used the following:
· Oscillator for identifying overbought condition
(when looking for short positions) or oversold condition
(when looking to a long position).
Appropriate technical indicators are RSI, MACD, CCI and the
Stochastics oscillator.
On Chart 18 you can see an example of long entry at 100 EMA
filtered by RSI (10) and Stochastics (5, 3, 3). Both EMA (20 and 50) cross
and go up, indicating that EUR/USD is in an uptrend.
When the price correction started and reached 20 and 50 EMA,
Stochastic confirmed the oversold condition, but the RSI was still in the
middle.
During the test of the 100 EMA, RSI made a double bottom just over
30, while the Stochastics crossed below 20.
At the same time the price formed several small candlesticks.
In such situations it is best to buy one pip above the high of the
consolidation.
The initial protective stop should be placed one pip below the low.
Usually on 1-minute chart you will risk up to 4-5 pips for EUR/USD,
which is perfectly acceptable.
EMA entry filtered by oscillators

Chart 18
· False breakout and a return above the moving

average (when seeking entry for a long position) or below
the moving average (when seeking entry for a short
position).
This type of signal is one of the best because the price first makes a
failed attempt for a break below or above the MA.
When the market shows that it cannot move in one direction, it
usually moves in the opposite.
Sometimes it is very convenient that the market has only two
directions and we should take advantage of this fact.
In such cases everything is clearly defined.
We wait for a correction of the trend and small break above or below
the average.
Buy 1 pip above (uptrend) or sell 1 pip below (downtrend) the
average when the price returns in the direction of the trend (Chart 19).
The stop is below the minimum or above the maximum reached after
break.
It is best to leave at least a 2-3 pips buffer.
If the break is too big it is better to skip the position, and wait for a
new signal.
Entry after a break above 20 and 50 EMA

Chart 19
One of the best entry levels are those where a moving average and
previous high or low coincide.
Sometimes a swing high or low forms and follows another leg in the
direction of the trend.
This price move does not last long and ends somewhere around the
last swing high (uptrend) or swing low (in a downtrend).
Then a new pullback follows and the price reaches a moving average
at almost the same price level where is the extremum of the first pullback
(Chart 20).
The coincidence of the two levels of support gives us the best
conditions for entry.
We buy when the price touches the moving average.
If the swing low is below the moving average (respectively if the
swing high is above the EMA for short positions), it is better to wait for the
price to reach it.
The initial protective stop is placed below/above the end of the first or
second pullback.
For entries on 1-minute chart of EUR/USD it is usually about 5 pips.
Entry at 20 EMA and previous swing low

Chart 20
Double or triple bottom on a tick chart

This is an aggressive type of entry and should not be applied by
traders who have little experience in trading and quote reading.
Once double (it is much better if it is triple) bottom or top is formed at
the level of the moving average buy after a downtick (within an uptrend) or
sell after uptick (within a downtrend), as shown on Chart 21.
The initial protective stop is usually 2-3 pips above or below the
double top or double bottom.
Quote reading entry
Chart 21
Moving averages are some of the best technical indicators and we can
design a trading system based only on them.
They play the role of dynamic trend lines and dynamic levels of
support and resistance, which gives them an advantage.
We have several options available to determine the exact level and
time of entry and protective stop.
This makes the moving averages suitable for all types of traders.
CHART PATTERNS
When the current price trend is losing momentum, the market usually
makes a pullback or enters a period of consolidation.
In such market phases swing highs and lows are being formed, which
could be used for drawing several lines of support or resistance.
Combining these lines, we can get clearly distinguished chart patterns.
They are divided into two main types – continuation and reversal
patterns.
The chart patterns are pretty simple and easy to use in my opinion.
Letters from readers showed me that this issue is more difficult than it
should be.
The reason for this is probably that it is approached in a purely
theoretical way, especially by novice traders who are not able to fully
understand the essence.
I will star with a brief explanation of the most important issues
concerning the chart patterns.
The main thing to remember about them is that they usually indicate
that the market is in a period of indecision.
Market participants that supported the previous price move have
exhausted their funds and need a little break before continue to buy or sell.
This break causes the price action that we see as some pattern on the
chart of the currency pair.
At the same time the opposing camp is not standing still and is
preparing for a new battle.
The chart patterns represent the preparation of both camps.
If the camp that have commanded the market so far, prepares better -
bars line up in formation for continuation of the trend.
The result of the battle determines whether the break of the
configuration is real or fake.
Chart patterns are of two main types – reversal and continuation.
The first indicates that a change is expected in the direction of the
price move.
The latter shows that, after some consolidation, it is more likely that
the previous trend will resume.
Knowing what chart pattern is in process of formation enables us to
find better entries and to determine with greater accuracy the potential risk
and profit.
The chart patterns enable us to predict with an acceptable level of
probability, the expected direction of the market and the price targets.
That's what I think is their main, and I would say the only real
application.
Do not try to learn the exact names of the various patterns.
It is sufficient just to remember if the pattern is more likely to reverse
or continue the trend.
Not that there is any absolute guarantee for this.
Trading the financial markets is associated only with probabilities and
any consideration of a method or approach as ‘the one and only’ could be
very dangerous.
I will list the main principles regarding the chart patterns formation.
If you can understand and learn to apply them in practice, you will
find various chart patterns with no need to memorize them.
You should look for chart patterns only if there was previously a
trend.
The larger the chart pattern, the greater the potential for the next price
move.
Tops are forming faster than bottoms.
The flag waves in the opposite direction.
Every chart pattern could fail.
The most popular trend reversal patterns are: head and shoulders ,
double top/bottom, rounded top/ bottom, 1-2-3 top/bottom, V - top/bottoms.
When you see one of these patterns you can expect that that the
direction of the preceding and subsequent price moves will be different.
You can find a lot of information about the chart patterns and I just
want to show you just a few examples.
The double top is one of the most common chart patterns.
The reason for this is its formation is based on elementary principles
of the price action.
What actually happens you can see on chart 22.
The pair EUR/USD was in a strong uptrend, the last leg of which was
about sixteen big figures.
On 20/04 the pair reaches a new high of 1.6019, and then begins a
pullback.
Clearly the market is taking a breath, and bulls gather forces to reach
new highs.
At 13/07 EUR/USD reached a new high of 1.6037. Notice that the
two peaks do not match perfectly, but on a weekly chart difference of 18 pips
is not fatal.
After the second high is reached, the new downtrend starts instantly.
Three periods later the swing low of the pullback is penetrated and the
euro bulls throw the towels.
EUR/USD double top

Chart 22
I want to explain what are the price action and order flows during the
formation of a double top or bottom.
First we have an established trend and the main cash flows and orders
are in its direction.
For some fundamental or technical reason some of the market
participants begin to open positions in the opposite direction.
Usually it is profit taking or top and bottom fishing.
This causes a pullback after e new high or low is reached.
If the trend is already in danger around this last extreme could be
noticed extreme accumulation of significant sell (in uptrend) or buy (in
downtrend) orders.
Behind them usually stay the same market players that have emerged
shortly before reaching the first top or bottom.
Those who supported the old trend, try a new attack to exceed the
previous price extreme.
They only managed to match the previous high or low before the
trend is reversed.
In the process of formation of the second extreme we can look for
signs of weakness on lower time frames.
This is one of the best times to open a position with great risk/reward
ratio.
If you notice suspicious activity of large market participants, watch
the news to find out who exactly id behind this.
One of the best signals is when the market suddenly finds out the
obvious.
Everyone knew that Greece, Spain and Portugal had debt problems,
but EUR/USD was in uptrend almost until the end of 2009.
The formation of 1-2-3 top or bottom is a result of one of the favorite
methods of large market participants - failed top or bottom.
At the financial markets things are not always what they seem to be
and that is exactly one of those cases.
Let us look at the phases of the formation of the 1-2-3 pattern.
Usually the trend for each currency pair is identified as successive
swing highs and lows.
When the price makes new high for example (point 1 on Chart 23) a
pullback usually follows. This pullback ends as a swing low (point 2) and
then a new leg in the direction of the trend begins.
Just when everybody expects the next higher high (as in the example),
the market turns lower (point 3) at first glance surprisingly.
New pullback starts before the previous price move ends.
Actually this pullback is the beginning of a new trend.
Usually the entry is at point 2.
Joe Ross recommends to look for an early position opening at point 3
using his Trader's Trick Entry (TTE).
USD/JPY 1-2-3 top

Chart 23
The head and shoulders pattern does not occur very often on a daily
chart of the currency pairs in a sufficiently pure form, but at smaller time
periods, we can notice it regularly.
The formation of this pattern requires more time, but the reversal is
likely, as we have a new extreme which was followed by a failed extreme.
It can be said that the end of the previous trend has a double
confirmation.
It is best to monitor the price action and the dynamics of trading
volume.
Unfortunately for the forex market it is almost impossible.
You can use currency futures volume, but you should know that this
is only a sample and does not represent the entire forex market.
The volume is usually largest in the formation of the left shoulder and
decreases for the next two components of the pattern.
GBP/USD head and shoulders

Chart 24
Chart 78 shows an example of a head and shoulders of GBP/USD on

hourly chart.
Initially, we have an uptrend where price reached consecutive swing
highs.
Realistically the formation of the first shoulder and the head, are no
indication of a possible reversal of the trend.
Actually these are consecutive higher highs and the trend is intact.
The warning follows the last component of the pattern - the second
shoulder.
The appearance of a new high which is lower than the previous one is
an indication that the bulls have problems.
Break of the neckline would show that the bears are already in
control.
In the example you see something that usually happens very often –
test of the breakout.
Probably this is the best point to open a position in the direction of the
new trend.
The risk/reward ratio is very good and we have confirmation of the
trend reversal.
If the former support that is now resistance holds, the situation
obviously changed and is good for us to join the new trend in the beginning.
The most popular continuation chart patterns are: flag, various types
of triangles, pennant, rectangle, wedge.
Common to them is that the consolidation takes place between two
lines, one of which is support, and the other resistance.
Differences are reflected in the extent to which the lines are parallel to
each other or to the x-axis.
These factors determine the specific names of these patterns. It is not
necessary to memorize these names because thus we concentrate on non-
essential activities.
Much more important is to observe and study in detail the price
movement around the levels of support and resistance, no matter if they are
separate or part of a configuration.
The rules are pretty much the same.
When the correction of the trend starts you can draw lines across the
swing highs and lows.
When the pattern has some shape you could start looking for an early
entry around the support line (in an uptrend) or the resistance line (in a
downtrend).
Another good option is to wait for a break out in the direction of the
previous trend and look for entry around the broken line.
Flag on the daily chart of USD/JPY

Chart 25
One of the most reliable and also the most common continuation
patterns are the flags.
They look like rectangles but the two parallel lines of support and
resistance are at an angle to the x axis. In principle, the currency pair quotes
must touch at least twice each border of the flag to complete the pattern.
Then we can expect a breakout in the direction of the trend.
The projected target of the new price move is at least the difference
between the lines of support and resistance.
Some analysts use the size of the handle of the flag to determine the
target.
On Chart 25 you can see the formation of this technical pattern on the
daily chart of USD/JPY.
The flag is perfect, as both lines were touched at least two times.
After the break a test of the resistance line follows.
If you want to save yourself problems and money, look for an entry
only during the test.
The first breakout is often false and thus unreliable.
Very rarely, new directional price move begins immediately.
In case it does, do not be upset that you've missed it.
Currency markets have been around for many years and probably will
be.
You will find many new trading opportunities.
Triangles, pennants and wedges are are also very popular chart
patterns.
You can find them on charts of all time frames.
These three kinds of continuation patterns are made up of two lines
that are not parallel to each other.
The difference is in the angle between the lines and the duration of the
consolidation.
If you keep in mind and follow the rules regarding the chart patterns,
it does not matter whether you have identified a symmetrical triangle or
pennant.
In most cases the break is in the direction of the previous trend, but
not be surprised if it is in the opposite.
Trade in the direction in which the price movement is more likely to
continue, but always use the protective stop if the market has other ideas.
Charts 26 and 27 present the same situation but in different time
frames.
On hourly chart we can identify a triangle, while on the 4-hour chart,
the same price action draws a pennant.
The difference is that for the pennant, the consolidation is shorter and
the breakout occurs after a small number of periods.
My idea with this example is to show you, that in your real trading, it
does not matter how you name, what you see on the chart.
More important, in both cases is that the previous price move is
downwards and this is the expected direction of the break out.
When we draw a chart pattern we usually have two price lines.
They give us important levels around which we should watch the
price action and look for entry.
In the example we should look for short position near the resistance
line or during the test after the breakout.
Triangle on 1-hour EUR/USD chart

Chart 26
Pennant on 4-hour EUR/USD chart

Chart 27
Let's see in detail the situation presented on Charts 26 and 27.

The five-minute chart shows perfectly the breakout of the pattern.
The price comes back up to test the broken support line after the first
leg down.
Actually before the 50-60 pips downward price move EUR/USD is
flirting with the support line for almost 4 hours.
During the first break of the support line, the quote go 5 pips below it,
and then goes back more than 20 pips up.
This means that your initial stop should be at least 25 pips.
Usually, in cases like this, your stop will be hit just before the price
goes south.
Look what happens after the test of the broken support line.
This time the initial stop could be just 10 pips.
After the break out is confirmed, the price tumbles and we can book
quick 50 pips profit.
Break out of a flag pattern

Chart 28
In Chart 29, you can see another pattern that looks like triangles, but
is called a wedge.
The difference in this case is that consolidation takes place in a
narrower range.
Therefore, usually the breakout is very strong and often there is no
test of the broken boundary.
Due to a consolidation in a narrow range the volatility contracts.
This makes the subsequent price movement much faster than usual. If
we want to join the trend, it is better to wait for the first pullback.
Wedge pattern

Chart 29
STATISTICS AND FOREX
Statistical methods are part of my trading system for the spot and
options (plain vanilla and binary) markets.
That is why I decided to discuss briefly several statistical tools and
how I use them in practice.
Volatility
Volatility is a measure of the variation of the prices of financial
instruments over time.
In practice, we use two main types of volatility.
Historical volatility is calculated based on time series of the prices.
The implied volatility is derived from the options prices of the
underlying asset.
The most important thing to know is that volatility is cyclical (Chart
30).
This means that periods of low volatility are followed by periods of
high volatility.
This characteristic of volatility is not accidental and comes from the
natural mechanics of the financial markets.
For a trend move to continue (period of high volatility) sufficient
number of market participants should invest their money in one direction.
The amount of money is not endless and after all the trend losses
momentum.
Some of the traders begin to take profits and others reduce their
exposure.
This usually leads to consolidation or pullback (period of low
volatility).
Volatility tends to revert to its average values, which could be used
very successfully in trading strategies with options.
The volatility is cyclical
Chart 30
Volatility can be measured by a variety of statistical indicators, but
the most popular are range, standard deviation and variance.
The range in trading is a measure of statistical dispersion and
represents the difference between the maximum and minimum values of a set
of data. This is the simplest measure of volatility, but it is good enough.
Range = Maximum value – Minimum value
Because sometimes the market opens with a price gap, it could be

more useful to use the so called true range.
This indicator represents the largest value of the difference between:
· Maximum and Minimum of the current period;
· Current maximum and the closing price of the
previous period (when the market opened with a gap up);
· Current minimum and the closing price of the
previous period (when the market opened with a gap
down).
In his book "New concepts in technical trading systems," J. Welles
Wilder describes the indicator Average True Range (ATR).
This is simply the arithmetic mean of the true price range for the last
"n" periods.
This indicator, although not as complex in logic and calculation, gives
us valuable information about the volatility of the financial instruments.
When the indicator values are very low, it can be expected that there
would follow a directional price move.
The main reason for this is the fact that periods of low price ranges
are typical for consolidation phases.
Chart 31 clearly shows that ATR (20) starts to decrease when the pair
trades in a range.
ATR(20)

Chart 31
Another statistical measure of volatility, that we can use, is the

standard deviation (σ).
This indicator gives us information about what is the average
deviation of the prices from their average for the last "n" periods.
With this indicator we can determine the volatility within a few days.
This way we can find out whether the market is trending or is in
consolidation phase.
The standard deviation is the square root of the variance (σ2), which
is calculated by the following formula:
∑(X – Xavg.)2
σ2 = -------------------------, where
N-1
X – price quotes
Xavg. – simple average of the price quotes
N – number of the price quotes
ATR and standard deviation

Chart 32
Unfortunately, these two volatility indicators are not used by many

traders.
I have noticed that long-term traders, always are looking to open
positions with higher profit target despite the fact that the market does not
really allow this to happen.
There is no way if the average range of a currency pair is 50-60 pips,
to trade with a 30-40 pips stop and be successful.
On Chart 32 You can see how to use simultaneously ATR and
standard deviation to get some idea of the volatility within one or more time
periods.
Note the areas marked by ellipses. In the first zone the market is
definitely trading in a range - ATR (20) declined from over 110 to less than
80 pips, while the standard deviation is collapsed from 220 to 60 pips.
This means that the volatility is very low intra-day and for longer time
periods.
In short, the market has no direction.
Under such conditions the trading is more difficult, and if we fail to
adapt our trading strategy in time, the consequences could be very
unpleasant.
From 31.10 to 12.11 there is a small downtrend, which broke through
the lower boundary of the range.
The closing prices deviated from their average and the standard
deviation increased.
However, the ATR (20) continued to decrease, indicating that the
intraday volatility was still pretty low.
ATR has a very useful application in the trading that is
underestimated by most traders.
Everyone knows roughly what the initial stop would be and what the
profit target for his average position is.
In Tables 2 and 3, you can see the volatility of some of the most
traded currency pairs respectively on 20.12.2012 and 21.05.2013, as
measured by ATR.
If we you see again Chart 32, you will recall that for EUR/USD the
end of 2012 was a period of very low volatility.
In comparison, I will tell you that the average daily range for October
and November 2011 was 180-190 pips.
The difference is huge and even needs no comment.
There is no way to trade with the same strategy and the same risk
parameters under so drastically different conditions.
You should constantly monitor the average daily range and fine-tune
your strategy.
You can also select the best currency pairs to trade.
For example, in Table 3, you can see that the average daily range for
USD/CAD is 50 pips, for NZD/USD is 59 pips, and for USD/JPY is 54 pips.
This means that it is almost impossible to trade these currency pairs,
especially if you are a day trader.
For example, if the initial protective stop is 20 pips and you want to
trade with a risk/reward ratio of 1/2 or 1/2.5, it means that you have to buy at
the minimum of the day and sell at the maximum.
This of course is not possible. In trading everything is based on
probabilities and we always have to keep this in mind.
Instead of looking for entries in USD/CAD, NZD/USD or USD/JPY,
it is more reasonable to trade EUR/JPY or EUR/USD, which respectively had
107 and 84 pips average daily range.
From Table 2 we see that five months later, the situation is different
and the average daily range of NZD/USD already increased to 90.7 pips,
while that of the USD/JPY jumped to 101.7 pips.
These values look normal and we can look for position entries in
these currency pairs.
Table 2 Table 3
The most valuable characteristic of volatility is that it is cyclical, i.e.

periods of high volatility alternate with periods of low volatility.
If you trade only volatility, you actually trade an asset that is in range
most of the time.
When a market is in range, our strategy is to buy around its bottom
and sell around the top.
To identify at what stage in the development cycle the volatility is at,
we can use the ATR or the standard deviation.
In some cases, however, we use the chart itself to determine when the
volatility contracts.
Then we can look for entries in a certain direction, or simply for
increase of the volatility, by spot position or options structures.
Inside bar (IB) or candlestick is one which maximum is lower than
the maximum of the previous period, and its minimum is higher than the
minimum of the previous period.
On Chart 33, you can see some examples of this short-term pattern.
When an inside bar appears on the chart we can trade it by placing
stop orders on both sides (buy above the maximum and sell below the
minimum).
Of course we can place only one order in the direction of the
prevailing trend.
For example, if the trend on the daily and 1-hour charts is bullish, and
on 15 minutes an inside bar (candlestick) forms, we can only seek entry for
long positions above its maximum.
An even better option is to wait for a false break of the high/low,
which is against the trend.
Then we can place a stop order to open a position after breakout of
the opposite high/low.
Much better results we can have if we wait to see on the chart several
consecutive internal periods.
This is an indication that the volatility has contracted significantly and
the break out is imminent.
Inside bar

Chart 33
In his book "Day Trading with Short Term Price Patterns & Opening
Range Breakout" Toby Crabel describes the Narrow Range (NR) price
pattern.
As its name suggests, this is the period with the lowest range of the
last "n" periods.
Toby Crabel uses mostly NR4 and NR7, i.e. the bar (candle) with the
smallest range of the last 4 or 7 periods.
Very good results could be achieved if you look for entries after the
formation of the inside bar, that is also a NR4 or NR7.
On Chart 34 you can see how this can be applied in your trading
strategy.
The stars mark periods in which are inside candle and NR4 at the
same time.
With this strategy, as well as any other, it is best to trade only in the
direction of the current trend.
Initially the EMAs are flat, which means that the pair is in a period of
consolidation.
After the 20 and 50 EMA crossed and went up, we assume that there
is an uptrend and start to look for opportunities to open long positions.
The setup is an inside candle that is also NR4.
More conservative traders may use NR7 instead of NR4.
They will have fewer but better trading signals.
When the volatility is much lower and a breakout followed by a
directional price move is more likely.
There is no way to tell which the better option is and each trader has
to choose one.
In the example I have highlighted only three signals, but the same
rules apply to similar cases.
After the first signal we cannot open a position, as the price breaks
against the direction of the current trend.
This is not fatal because if the trend continues we will have a new
trading signal.
It is better to skip the set up if it is not confirmed by the price action
and to avoid an unnecessary loss.
The second case is interesting because the inside candle is formed
after test and a sharp bounce (long lower shadow) off the 100-period EMA.
Such a sharp return after test of a moving average usually indicates
that someone is buying.
The outcome of this position depends on its management.
If you choose the passive approach (wait for the market to hit the stop
or limit \) you will probably have a loss of about 8 pips.
The better way is the active position management.
You can close the position in 2 or 3 parts and also use time stop
(limit).
In this example, the first part will be closed for about 8-10 pips profit,
second possibly at break-even, and the third will be stopped for 8 pips loss.
The third signal is generated after a new test and even small break
below 100 EMA followed by resumption of the upward price move.
This time, the initial stop is 8 pips, but the development of the
position is much better.
The pair continues its upward movement, and the maximum profit is
40 pips.
Of course the end result depends on your position management rules.
You can read more about this in my next book.
Inside candle + NR4

Chart 34
Using the properties of the volatility can be very useful for improving
our trading system or to develop a new system based on this alone.
The cyclical nature of volatility allows us to open positions with a
much better chance of success, and with less risk.
This cycle can be traded very successfully with options strategies.
Correlation
The correlation is a statistical indicator, which measures the
relationship between the two variables.
Respectively in the financial markets we look for correlation of the
prices of different financial assets.
Correlation is measured by the correlation coefficients, the most
famous of which are those of Pearson, Spearman and Kendall.
The values of the correlation coefficients are between -1 and 1.
I will not bore you with more theory on the subject, and even I'm not
going to explain what are the exact formulas for calculation of the correlation
coefficients
. There are enough custom indicators for MetaTrader. Also with
historical data you can use the functions of MS Excel or OpenOffice.org Calc
to calculate the correlation between two financial asset.
In practice, what we need to know is that the correlation is positive
and negative.
Positive correlation occurs when an increase in one variable increases
the value in another.
Negative correlation occurs when an increase in one variable
decreases the value of another.
Correlation also could be strong and weak.
In general, when we have a strong correlation, the coefficient must be
above 0.90 or below -0.90.
In all other cases, the correlation is weak. In Tables 4 and 5 I have
shown the correlation between some of the most popular currency pairs on
the basis of the closing prices of hourly and daily charts.
From these tables we can analyze which currency pairs are moving in
sync and which not.
Furthermore, we can compare the correlation in different time frames
and on that basis to do statistical arbitrage.
It is very important what data set exactly is being analyzed.
Of course this has to comply with the purposes underlying the
analysis.
For example, the correlation between GBPCHF and GBPJPY on a
daily basis is -75 (if you analyze the last 200 periods) and 61 (if you analyze
the last 50 periods).
When we see such a discrepancy, we must find out the reasons and
whether they might have some influence in the future.
Correlation on hourly basis
Table 4
Correlation on daily basis
Table 5
The correlation between the currency pair that I trade and various
financial assets plays an important role in my trading strategy.
Unfortunately, the relationship is not always valid, and sometimes
cannot be used.
For example, there was a good correlation between the so-called risky
assets from approximately 2006 to 2012.
In this group were currencies such as the Euro, British pound and the
Australian and New Zealand dollars, stock market indices, gold and other
commodities.
This greatly facilitated the trading of the currency pair EUR/USD.
Entries in EUR/USD could be filtered with the price movements of
EUR/JPY and GBP/USD, and a stock index such as DAX, FTSE or Dow
Jones Industrial Average.
When i was looking for a long position in EUR/USD at the 20-period
EMA, I waited EUR/JPY to test the same or another moving average.
Furthermore, all correlated financial instruments had to move in one
direction, as the best entries were obtained when the EUR/USD lagged
"behind" the others and had to catch up.
When the correlation is strong enough it could be used also in the
position management.
For example if I have a long position in EUR/USD, but EUR/JPY and
DAX stop their upward movement or even turn down, I would close all or
part of my long.
The other option is to move my protective stop closer to current
market levels. Major market players like to trade various assets at the same
time, when market conditions allow it, and it is good to take advantage of
their habits.
Unfortunately, correlations do not always work reliably.
For example, during the last few months there was a good correlation
only between EUR/USD and GBP/USD.
The correlation coefficient for the past 50 days was 0.80, but for the
past 200 days it was only 0.03.
The correlation between EUR/USD and EUR/JPY turned negative.
The good news is that the correlations have the ability to get restored.
Years ago when trading EUR/USD, I filtered my trading signals with
the price movements of GBP/USD, USD/CHF and USD/JPY.
There were periods when you could trade successfully Gold
(XAU/USD), using its correlation with the EUR/USD.
The correlation is a good tool to trade various commodities, indices or
stocks that have good price relations.
You just have to analyze the correlation between the different
financial instruments and to select those that are appropriate for so called
pairs trading (or statistical arbitrage).
On Chart 35 you can see the correlation between two of the most
popular stock indexes S&P500 and the Dow Jones Industrial Average.
In principle, the correlation between these indices is very high and is
regularly 0.97-0.98.
When you find such a strong correlation you can compare the values
of the correlation coefficient calculated for a longer period, with one that is
calculated for shorter (Chart 36).
When the balance between the two indicators is impaired, you may
get opposite positions in the two indexes, waiting for rebalancing.
S&P500 and Dow Jones Industrial Average
Chart 35
10- and 20-day correlation
Chart 36
Seasonality
Seasonality of statistical time series is a concept associated with
predictable cyclical changes that occur within a specified period (usually a
year).
Usually seasonality is analyzed on annual basis, but the same methods
can be applied for smaller time periods.
For example, using seasonal analysis of forex quotes throughout the
day, we can analyze the intraday volatility.
Based on this analysis we can improve significantly our position
entries on the spot market or trade the changes in volatility with options
structures.
Seasonal factors have a very strong effect on most of the exchange-
traded commodities.
For example, corn and soybeans planting begins in April and the
harvest in October.
The whole process of growing of these agricultural commodities is
associated with a variety of risks that arise each year at the same time.
They are reflected in the prices of the futures contracts, and then taken
out.
Therefore the seasonality is very well established, and can be used for
developing of trading strategies.
These strategies could be traded through outright futures positions,
spreads (we buy one contract and simultaneously sell another) or options.
On Charts 37 and 38 you can see the seasonality of the soybeans and
corn futures prices.
Very interesting is the so-called building of the risk premium in the
price and then its removal.
As I said, the sowing of these two cultures begins sometime in April
in the northern hemisphere.
Since there is no guarantee that this process will go smoothly, but it is
very important to get everything right, the prices of soybeans and corn begin
to rise.
The main reasons are the risks associated with the sowing of seeds
and the process of vegetation.
The pricing of the risk premium is resulting in a seasonal upward
price move, which can be traded each year.
In June and July the expectations for the size of the crop are largely
clear. During these two months, the risk premium is removed from the price,
which leads to its seasonal decline.
Seasonality of soybeans prices
Source: www.seasonalcharts.com
Chart 37
Seasonality of corn prices
Chart 38
Similar seasonal effects are common for almost all underlying assets.
You do not even have to be an expert in the field to trade them.
There are web sites that provide seasonal analysis and charts, as one
of the most useful are www.mrci.com and www.seasonalcharts.com. Moore
Research Center Inc. (MRCI) offers very good services, and seasonal charts.
They also provide statistics for the positions they recommend.
Seasonality could be traded via outright futures positions and futures
spreads (now they are available also through contracts for difference - CFD).
Futures spread are positions of two contracts. We always sell one of
them and buy another.
Spreads can be between two underlying assets (for example, buy corn
and sell wheat) or between two different maturity months of an asset (buy
July and sell December corn futures).
When we trade spreads, we have the advantage that seasonal factors
are supporting, and also one of the contracts is hedging the other and the
losses are smaller.
Now I will give a few examples of different types of seasonal
strategies.
This will make it clear how they could be implemented.
On Chart 39, you can see the seasonality of the futures of the
Australian dollar.
Each year, MRCI recommends opening a long position in the first day
of June, which is held to 26 June.
For the years 1998 to 2012 14 positions were winners with only 1
loss.
In 4 cases positions never had even a paper loss, but there were also
several current losses of 2 or 3 big figures.
The average profit is 2,171.86, and the average loss 3,340.00.
The average financial result per position is 1,805.33.
AUD seasonality
Source: www.mrci.com
Chart 39
Seasonal spreads are an excellent, but unfortunately little known
strategy.
Trading seasonal spreads would require more resources, but it is
worth considering. On Chart 40 you can see seasonality of the spread
between July futures of Heating oil (HO) and RBOB gasoline (RB).
This is an intermarket spread. MRCI recommends buying futures of
HO against selling futures of RB (both July) on June 1.
The position is closed at June 21st. For the years 1998 to 2012 there
are 13 winners and only 2 losing positions.
The average profit is 444.20, and the average loss 1,008.00, making
an average result 1,280.72 profit per position.
HO/RB intermarket seasonal spread
Source: www.mrci.com
Chart 40
Intramarket spread comprises a long position in one contract month
against a short position in another contract month in the same underlying
asset on the same futures exchange.
In the example shown in Chart 41, we buy natural gas (NG) futures
maturing in December and sell NG futures maturing in October.
The position is usually opened on May 1 and closed on 10 July.
For the period from 1998 to 2012 there were 13 winning and only two
losing positions.
The average profit is 1,276.92, and the average loss of 960.00,
making an average profit per position of 978.67.
NG intramarket seasonal spread
Source: www.mrci.com Chart

41
On the charts 42 and 43 you can see the seasonality of EUR/USD and
JPY/USD.
This type of analysis could be used by mid- to long-term traders to
refine their entries based on daily charts.
The depreciation of the U.S. dollar against the euro in the past few
months of the year is very clear. This seasonal effect could be traded, if
relevant signals are generated by technical or fundamental analysis.
EUR/USD seasonality
Chart 42
JPY/USD seasonality
Chart 43
Seasonality is very strong for the stock indices. They have very clear
seasonal effects that can successfully be used in trading.
Chart 44 shows the seasonality of the S&P 500. This chart shows
where the saying ‘Sell in May and go away’ comes from.
Moreover, the appreciation of the stock prices at the end of the year is
very typical phenomenon. This fact is not accidental and is due to the
willingness of managers of investment funds to show better results, as well as
coupon payments on debt securities, which are used for buying of stocks.
S&P 500 seasonality
Chart 44
Methods for the analysis of seasonality can be used to model the
intraday volatility of the prices of financial instruments.
Volatility is influenced by the cash flows that are in the forex market.
When we have an idea how it is amended we can filter better its
inputs. For example, it makes no sense to trade breakthrough configuration if
he will be in a period of decreasing volatility.
Accordingly, if we want to buy support and sell resistance, it is better
to do it in a period of low volatility, because then there is less likely to break.
These are fine-tuning of the inputs, but in the long run are justified,
and it does not require effort.
Seasonal indices could be used for analysis of the intraday volatility.
This is not a complicated process, but in this case it is very efficient.
First, the data are grouped by periods (eg hours of the day and months
of the year), and for these periods are calculated the averages.
Then we should calculate the average for all data of the time series.
After we have all the averages we can calculate the seasonal indices
for the periods.
This is done by dividing the average for the corresponding period to
the average of the whole time series.
When we plot the seasonal indices on a chart we can see the profile of
the intraday volatility for the financial instrument.
On charts 45 and 46 you can see the change in the volatility on
intraday basis for EUR/USD and Gold.
The first chart shows clearly how the volatility of EUR/USD is lower
during the Asian session and increases with the opening of London.
Volatility of this currency pair is highest when the largest financial
centers (London and New York) overlap.
EUR/USD intraday volatility (time in CET - GMT+2)
Chart 45
For the gold prices the volatility profile is different from that of the
major currency pairs.
Precious metals are traded almost around the clock, but the trading is
more active during the official CME session, which is from 7:20 to 12:30
local time (Chicago).
The chart shows how after the start of the official trade volatility rises
sharply.
This fact could be traded very well with options or option structures,
as we have directional price move and increased volatility.
GOLD intraday volatility (time in CET - GMT+2)
Chart 46
With the method of seasonal indices could be analyzed also the
volatility of currency pairs on an intraweek basis.
Chart 47 shows the results for the EUR/USD.
The conclusions that we can draw is that Monday is the best day of
the week to trade range.
If you prefer to trade trending price moves the best days are Thursday
and Friday.
This analysis gives us a lot of valuable information, especially if you
are trading with options and option structures.
EUR/USD weekly volatility
Chart 47
Volatility of financial instruments can be analyzed on an annual basis
also.
Chart 48 shows the profile for EUR/USD. You can see some key
dependencies.
Volatility decreases during the summer months and at the end of the
year and rises early in the year and during the fall.
Based on the profile of the volatility you can filter your entries.
Also you can trade the seasonal effects on volatility through options.
Remember that option prices depend largely on the volatility and this
happens to be another advantage we can use.
EUR/USD volatility
Chart 48
In this chapter of the book the idea was to show you how you can use
statistical analysis methods to improve your trading.
The biggest mistake most traders make is that they are trying to trade
only the direction of the price move.
Much easier is to trade the volatility because it is cyclical and it is
easier to predict. Furthermore, this interchange of periods of high and low
volatility is caused by the natural mechanics of the financial markets and
therefore can hardly be influenced by random factors.
As you can see, the volatility can be modeled with simple statistical
methods. It can be applied as an additional filter when we select the financial
instrument to trade or for the opening and management of the position.
You may expand your knowledge in this topic and see how to analyze
seasonality using regression analysis when the market is trending.
HOW TO READ THE CANDLESTICKS
If you want to be able to analyze the price action you have to know
how to read the individual bars or candles.
As everyone knows there are a variety of candlesticks patterns, but
not all of them give us valuable information.
Therefore, we must be able to recognize several of them that show us
best what is happening now in the market.
We are mostly interested to know whether the bulls or bears prevail
and what are the prospects this power balance to be maintained.
To put it another way, is there a trend, in which direction this trend is
going and to what extent it is likely to continue.
Let's start with the bull and bear trend candles (Chart 49).
Typical for the first kind is that the opening price is close to its
minimum, and the closing price is close to its maximum.
Respectively, for the bear trend candle, the market opened near its
maximum and closed near its minimum.
These two types of candles show that one of the two teams have a
serious advantage at the moment.
However, if several trend candles appear one after the other, it can be
expected that the movement is running out of steam and the market is
approaching overbought or oversold condition.
In such cases it is reasonable to reduce the risk by closing part of the
position or moving the stop closer to the current market quotes.
When you see a big white or black candle during a breakout, probably
around that level were hit stop orders.
Subsequent price action can give us more information whether this
was done only to provide liquidity or to continuation of the trend.
Bull and bear trend candles
Chart 49
Bull or bear trend candles on 1-minute chart show that large orders
are filled.
This is often an indication of an impending directional price move.
On Chart 50, you can see how the downward trend was reversed after
the formation of 1-2-3 bottom.
At the beginning of the new uptrend large bull candle appear,
indicating that the market had attracted serious buyers.
When we see a similar situation, we can open a position in the
direction of the new trend at its early stages.
The best option is to wait for the first pullback and look for an entry.
On Chart 51 you can see what happened after that 1-2-3 bottom.
Read the quotes and the candles and you will know what is coming
next much earlier that the other market participants.
Bull trend candles show that big buyers entered the market.

Chart 50
Uptrend

Chart 51
While the trend candles show that the bulls or bears control the
market, small range candles indicate just the opposite.
They indicate indecision of the market participants and in such cases
it is better to wait until the situation is clarified before open a position.
As I already wrote, they are a good option to look for entries in
anticipation of increased volatility, but it is good to traded only by
experienced traders.
Because of the uncertainty, many false price moves could happen and
you must have sufficient experience to judge better the current market
situation.
To improve the probability you could add additional conditions, e.g.
the position to be open only in the direction of the prevailing trend or to wait
for second break out.
It is important to recognize quickly and accurately one candle reversal
patterns.
They give us timely information that the current price move can be
approaching its end and it is good to consider entry in the opposite direction.
On Chart 52 I showed three of the most popular patterns. Their form
shows that after the opening of the period, prices attempt to continue their
movement in the direction of the current trend.
However, this attempt fails, and the market closes near the level at
which it has opened (falling star and hammer) and/or mid-range (doji).
Also, if within an uptrend a candle with black body and small
shadows appears, it can be considered a reversal pattern. The same is true for
a candle with white body within a downtrend.
The presence of a long upper or lower shadow indicates that large
limit orders in the opposite direction are clustered around a support or
resistance level.
When the price approached this level, these orders were activated and
returned the market in the opposite direction.
When using one candle patterns to open a position, the entry usually
must be at least 1-2 pips beyond the high/low, which is against the current
price move (e.g. 1 pip above the high).
The initial protective stop should be placed at least 1-2 pips beyond
the other extreme of the candle.
One candle reversal patterns
Chart 52
Reversal patterns can also consist of more than one candle.

Of course the formation of two or three candle patterns will take more
time.
Also the initial protective stop should be slightly larger. On Chart 53,
you can see some of the most popular candlesticks reversal patterns.
Typical for all of them is that they almost always start with candle
with the color of the direction of the old trend, and finish with candle with the
color of the new trend.
In some patterns, these two trend candles are separated with another
candle, which indicates indecision of the market participants.
On a higher time frame charts these patterns will form one candle
reversal.
For example, bear engulfing will look like a shooting star on a chart
with a higher time frame.
Reversal patterns of more than one candle
Chart 53
Reversal candle patterns are most useful around the levels of support
and resistance.
They can provide information on whether there are orders in the
opposite direction.
On Chart 54 you can see the test of a resistance level. The big white
candle is evident that the bulls are buying aggressively.
However, during the first attack, bears have also shown strength, as
we can see from the black trend candle.
New attack is launched, but a doji (not always the opening and
closing prices are exactly the same) appears on the chart, followed by two
candles with large shadows.
Note that the downward movement started after the candle with large
upper shadow.
It shows that at that moment large sellers entered the market and
started the new downtrend.
On Chart 55 you can see what happened after that.
Reversal candles around resistance level

Chart 54
Downward price move

Chart 55
QUOTE READING
„If you can learn to follow the price action, you will be two steps
ahead of the game because price is faster than any derivative. You may have
heard the saying, “The only truth is the current PRICE.” Your job as a
trader will become ten times easier once you accept this.“
- Linda Raschke
The earliest stage of the flow of information we can join are the price
quotes.
Of course someone may have as a friend a manager of large
investment fund, or a senior FX dealer of a major bank in London, but these
are rather exceptions.
Moreover, you cannot be sure that your friend will tell you in advance
that a large buyer of EUR/USD has just placed an order.
For the ordinary traders the only option is to learn to read the price
quotes. This way they could understand what is happening in the FX market
long before the other participants.
Changing of the price quotes contains much more information than
many traders realize. If you just analyze the consecutive ticks (the change in
the price from trade to trade) you can have an idea, with a good degree of
confidence, if there are big orders around a support or resistance level.
Also you will know if someone continues to open positions in the
direction of the current trend, or some large market participants are trading
against the trend.
Reading quotes is very useful in cases when large stop orders are
activated, above resistance or below support level.
Quote reading is based on one very simple principle – large tick
means large order was executed. That is all about quote reading.
What you have to do is to spend enough time watching the quote
board. Soon you will be surprised at the ability you gained to “feel” the
market.
Let's see what the quote reading is based on.
The currency market is an OTC and we cannot obtain the full
information about all orders at a time.
Fortunately, there are certain principles that are valid and that we can
use in our analysis. In order for price to move from one price level to another,
all orders between them must be filled.
The quotes cannot jump up and down just like this. Let's assume that
at some point we have the following volumes of EUR/USD orders at these
price levels:
Table 6
If the quotes have to go from 1.3144 to 1.3145, someone has to buy

€15 million against USD. For an increase of the FX rate by 5 pips to 1.3149,
someone has to buy all the quantities between this level and the current
1.3144, or €85 million. Accordingly, for a 3 pips price move in the opposite
direction, someone has to sell an amount of €70 million.
Let's assume that some large hedge fund plans to open a long position
for 50 million euros. If we use the data shown in Table 3, there is no way to
buy the whole amount at the current ask of 1.3145, since there are only 15
million euros offered.
Unfortunately, the order could not be filled at 1.3146, as the available
amount for both levels is 40 million. Transaction can be completed only at
1.3147, which means that the price of the execution of the last part will be
higher by 2 pips from the current rate.
The difference between the quote we see on our trading platform and
the price the order is filled is called slippage.
If the manager of that fund must execute the transaction immediately
at any cost and has no time and opportunity to seek liquidity otherwise, we
will see a jump in quotes.
The quotes will move with a larger tick from 1.3144/45 to 1.3146/47.
By the size of the ticks, we can assume that large orders are executed on the
market.
The bigger the tick is the larger the order that has been filled. When
the consecutive ticks in one direction are larger than the ticks in the other
direction, it is more likely that the market is trending.
For example if the upticks are bigger than the downticks we can
expect that the price will move higher.
If the sizes of the ticks are getting equal, we can expect that the price
move will slow down or even stop.
Sometimes you will notice that there are no large-sized ticks, and no
several consecutive ticks in one direction.
In such cases it is most likely that there are no large traders at the
market and a trending price move could not be expected.
When the market has no clear direction it is better to wait or to trade
with increased caution.
The currency market is decentralized, but every trader is dealing with
a specific broker and what matters is the size of liquidity they provide.
If you look at the Level 2 (L2) quotes on the platform of any ECN
broker, you can see exactly how big slippage you can expect in the execution
of an order of a certain size.
Table 7
Table 4 shows the liquidity for the currency pair EUR/USD provided
by a large ECN broker.
What conclusions can we draw from this information? At this
moment we cannot sell more than 500,000 units of the base currency or buy
more than 1,000,000 without slippage.
However, If you want to sell the sum of 3,800,000 you will incur 0.2
pips slippage.
Accordingly, if you want to buy more than 9 million will have
slippage of at least half a pip.
With these numbers the individual traders operate very rarely, but it's
good to know the basic mechanics of the currency market in order to
understand the logic of the quote reading.
Now I will discuss in more detail three main cases in which we can
successfully implement the quote reading.
In my trading system I use the quotes as an additional filter for the
position opening.
Usually I buy at support and sell at resistance level.
These levels could be a combination of swing low or high, moving
averages and Fibonacci level on 15 minutes or one hour charts, or simply the
20-period exponential moving average on 1 minute Chart.
Changing of the quotes around such levels can indicate whether there
are large orders in the direction in which I intend to open a position.
When I want to buy, I wait for a double or triple bottom to form on a
tick chart (Chart 21) near the level of support.
Accordingly, if the entry is for a short position a double or triple top is
a good sign that someone else is also selling.
At the next tick to the selected level I will buy or sell with a market
order. The stop is usually 2-3 pips on the other side of the pattern and usually
for entries on a 1-minute Chart is within 4-6 pips.
It is imperative that the pair is approaching the level with smaller ticks
(eg 0.5-0.9 pips) compared with those when it bounces off the level (eg 2-3
pips).
This indicates that the order in the direction in which we will open the
position, are larger than those in the other direction.
On Chart 56, you can see the road map that I draw every morning
around 08:00 AM local time (06:00 AM London time).
The basic idea is to identify potential levels of support and resistance
around which I will look for entries.
In this case, a good level to buy is 1.3070. There are overlaping
previous swing high, 50-hour EMA and pivot (S1).
However, position will be opened only when the quote reading around
this level indicates that a large market participant is buying.
On Chart 57, you can see the test of the support at 1.3070. In this
case, the first bounce off the support is with a tick of 7.5 pips, which is
significantly larger than the size of the ticks during the approach towards the
level.
So large ticks are not seen very often, but in this case we understand
that a market participant with serious financial capacity has decided to buy at
the same support.
There's nothing more we could want and we just have to wait for a
new test. A few minutes later this test is a fact and we buy on a downtick
towards the support level.
Our entry price should be as closer to the support as possible, because
we want the smallest possible initial stop.
The mechanics of position opening by large funds is in our favor in
such situations. They cannot afford to buy or sell the whole amount at once,
because the price at which they will be filled would be worse because of the
slippage.
Therefore, they buy a few parts every downtick or sell at every uptick.
This process is the reason for a double or triple bottom/top to form around the
support or resistance level.
This enables us to open a position at very good price with a much
smaller stop.
Road map

Chart 56
Tick chart
Chart 57
Sometimes the big players do not wait for the price to test the level of
support or resistance, and start buying or selling at the current market levels.
The reasons for such actions may be different, but in any case most of the
other traders are surprised and forced to open or close positions, thus giving
further momentum to the new price move.
There is no way to know in advance that such an event will happen as
hardly anyone will inform us about it.
However, we can always recognize a large tick in any direction,
which means that a large market order was executed.
If someone has decided so bravely to buy or sell, it can be assumed
that this process will not stop after the first order. So when we see a similar
situation, it is better to wait for a pullback and seek an opportunity for entry.
We can use the quote reading also for position management.
The size of the ticks can help us to get a sense of what is happening in
the market right now. This way we can see whether the bulls or the bears
have control over the price action.
When the upticks are larger than the downticks it is reasonable to
assume that the buyers are stronger than the sellers and the path of least
resistance is to the north.
Accordingly, if the downticks are larger than the upticks the bears
have control and we can expect downward price move.
On Chart 58, you can see the ticks of EUR/USD.
The pair is in a downtrend and we have a short position. At the
beginning of the pullback everything is according to the rules – the upticks up
are smaller. At one point, however, bears attempt to resume the downward
trend, as evidenced by the large downtick.
Bulls obviously have other intentions as this could be seen from the
big uptick. This means that a large buyer is at the market now.
In such cases it is better not to wait passively what will happen, but
rather take some action.
Remember that what you have seen now from the quotes, the other
market participants will realize just after it is depicted on their charts.
Some of them will know this at much later stage just after their
indicator shows something is wrong with the current trend. It is not
necessarily to close immediately the entire position. You we can close part of
it or just move the stop closer to the current market price.
Tick Chart
Chart 58
On Chart 14, you can see what happens afterwards.
The pair makes a greater pullback before the downward price move
resumes about 4 hours later.
In such cases, if I see indications of the presence of large orders in the
opposite direction, I prefer to take my profits.
New setup will appear sooner or later and I can trade it. Don't give
back the money you have taken from the market.
Preservation of capital is essential for your success as a trader from
financial as well as psychological point of view.
What happened next...

Chart 59
In my previous book I discussed the topic of stop hunting that major

market participants use to find liquidity.
Realistically there is no way to know in advance what their intentions
are and when to open a position in the right direction.
One option is to wait for a reversal candlestick pattern after the stops
are activated and use its extremes to determine the entry and initial stop
levels.
In this case, however, the risk will not be very small, as it is better to
use at least 5-minute Chart. To reduce the size of the initial stop, we can
apply more aggressive approach with the assistance of quote reading.
The rules for entry around support or resistance level could be
applied. Wait for stops to be triggered and watch the tick chart. Actually I
watch the quotes on the quote board of my trading platform but it is a matter
of preferences and experience.
The process of activation of stop orders will be plotted as few
consecutive larger ticks on the chart (Chart 60).
If someone really intends to reverse the market in the opposite
direction, it will start buying or selling immediately after the stops are hit.
The liquidity necessary for opening of a large position is obtained and
there is no time to waste. So if you see a double or triple bottom/top on the
tick chart, you may join the party.
The protective stop should be placed just above the high (respectively
below the low) reached after the stop orders were activated.
The example on Chart 60 is not depicting this scenario, because
obviously a very big buyer appeared.
Quotes went back up quickly and did not even try to make a second
attempt to continue the downward price move.
In such a situation super aggressive traders, who have enough
experience, can seek double bottom at the first pullback on a tick chart.
The right approach is to wait for the moving averages on 1-minute
chart to indicate the beginning of a new trend and look for entry on the first
pullback.
Basically, trading immediately after stops are hit (Chart 60) is
extremely risky because we try to open a position against the direction of the
last price move.
If, however, by reading the quotes we have a reason to believe that
this is done only to provide liquidity, aggressive approach is not as dangerous
as it seems.
Of course, we have to review the current situation in the context of
the overall price action. Let's assume that the stops are below support and the
market is in an uptrend on a higher time frame.
In this case the probability for continuation of the downward price
move is very low. Looking for a long entry after the stops are hit seems pretty
reasonable idea.
In trading much more important is the money management and if it is
properly applied and because of that there is no such thing as a risky position.
In case you are right that the stops are used for liquidity purposes you
will end up with a position in the right direction at the very beginning of the
new price move.
As a bonus you will have very little stop and great risk/reward ratio.
In most cases, it will be at least 1:5.
Talking about risky trades? I don't think so.
Stop hunting on tick chart
Chart 60
Quotes reading may seem a bit like stargazing, but this is the only
approach we can use to gain some insight into what orders are executed at the
time.
The currency market is decentralized and unfortunately there is no
way to get reliable information.
However quote reading can give us valuable information on whether
someone buys or sells at some support or resistance level, and if the current
price move still has enough supporters.
This way we will have useful information that will allow us to open
positions with smaller initial stop and better risk/reward ratio.
In trading to be smart is not enough. You have to outsmart the other
market participants to make money.
In a zero sum game someone has to lose in order for someone else to
win.
Joe Ross
More than 10 years ago I heard about Joe Ross and decided to learn
more about his trading style.
Before that, I was impressed by Larry Williams, but back then there
was not much information about him.
Before I continue I want to tell you that "The Law of charts" was
good enough to learn the basics of Joe Ross' strategy.
The most interesting thing for me was the so called Trader's trick
Entry (TTE).
This is one of the most important things that I have learned during my
life as a trader.
If you want to be a profitable trader you must have some advantage
over the other traders. Period!!! You may know all technical indicators, chart
patterns, Elliott wave theory, etc.
If you don't know the forex market and have an advantage based on
this knowledge, you are doomed.
Joe Ross' trading philosophy is very simple and logical. It is based on
the principles of the price action analysis.
In this section I don't want to describe everything that Joe Ross
teaches. My idea is to make it clear, that it is useful to study the style of
trading of other traders by reading books, watching seminars and webinars.
Don't try to copy someone else's strategy 100%. You just have to
constantly study different new ideas and strategies, but use only what you
believe will improve your trading style.
Certainly don't go too far in studying other people's strategies. There
is a real danger that you may end up as a collector of strategies and never
become real trader.
Now I will briefly outline the main concepts of Joe Ross' trading
style.
For trend reversal, he describes the 1-2-3 top and bottom patterns.
As can be expected, the 1-2-3 top reverses an upward trend. In this
pattern, first we have a new trend high (point 1), followed by a pullback to a
swing low (point 2).
After this pullback the trend resumes, this time to form another swing
high (point 3), which is lower than the first one.
This lower high indicates that the bulls are already losing control of
the market and the sequence of consecutive higher highs and lows is violated.
The uptrend is no longer intact and a major pullback or trend reversal
could be expected. You have to remember that nothing is sure when you
trade.
Everything presents huge number of opportunities to profit and your
job is to learn how to spot them.
The classic entry is after the break below point 2, with initial stop
above point 1 or point 3.
1-2-3 Top/Bottom
Chart 61
Accordingly, in a downtrend the market reaches a new swing low

(point 1), then follows a pullback up to swing high (point 2). Then the
downtrend resumes and reaches new higher low (point 3).
This is an indication that the bears no longer have enough strength
and the sequence of lower highs and lows is broken. Break above point 2
gives a signal for long position. The initial protective stop should be below
point 1 or point 3.
The best thing about trading 1-2-3 tops and bottoms is the fact that we
enter in the new trend right at its beginning.
This gives our position very serious profit potential and thus one of
the best possible risk/reward ratios.
The only problems are that the stop is not so small, and often the
break of point 2 is false.
Joe Ross describes several forms of consolidation, depending on their
length and duration:
Ledge (Chart 62) - this is a pattern of 4 to 10 periods. The ledge must
exist within a trend. There must be at least two bars (candles) with matching
highs and lows. An additional requirement is that the matching highs and
lows are not in consecutive periods.
Ledge
Chart 62
Trading range (Chart 63) - this pattern consists of more than 10
periods. Joe Ross calls the consolidation between 10 and 20 bar „congestion“.
If for 10 periods there is no breakout, this means that the direction of
the market is uncertain. The market participants will need to gain more
strength and earn enough information to move the prices in any direction.
After the twentieth period, however, consolidation is taking too long
and a breakout could be expected. In this case, it comes back to the cyclical
nature of volatility,
I talked about this in one of the previous chapters. There are a few
basic principles in trading, that and if you learn and start applying them
everything becomes much clearer and easier.
Trading range

Chart 63
Ross hook (Chart 64) is formed after the first correction after a
breakout of 1-2-3 pattern or consolidation (ledge or trading range).
During an uptrend Ross Hook is created, after a bar makes lower high
than the previous one. During a downtrend Ross Hook is created, after a bar
makes higher low than the previous one.
In other words, the Ross Hook shows that the current leg of the trend
is completed and a pullback begins.
Correction of the trend is the best time to look for entry in the
direction of the major price move. Whenever we consider a trading strategy
or style, we must find the basic logic it is built upon.
If it does not seem normal to us, there is no need to waste time.
The idea of Joe Ross is to identify the directional price move. Its
beginning is a breakout of 1-2-3 pattern or consolidation. Then he waits for a
pullback and looks for position entry.
Actually, after a break of the Ross Hook, the trend resumes and must
be formed new higher high (uptrend) or lower low (downtrend). Classic entry
is to open a position after the breakout of the Ross Hook. In this case we will
have some problems. The stop is a larger, and often the breakouts will be
false.
Ross Hook

Chart 64
The entry after a Ross hook should be after the breakout, and the stop
must be beyond the high or low reached during the correction.
This is done because according to the classical definitions up and
down trends are respectively sequences of higher or lower swing highs and
lows. To avoid some unpleasant surprises as false breakout or hitting a large
stop, Joe Ross offers an early entry technique, which he called the Trader's
Trick Entry (TTE).
The idea behind TTE is it lets you open a position before the majority
of market participants, and reduces significantly the initial stop.
Position is opened early, after a break of an extremum of a bar
(candlestick) of the pullback. If, after the breakout of the Ross Hook the trend
continues, we will have a position at a better price.
We can also close part of it and cover the initial risk.
In case of a false breakout, we can end up with a small loss or even a
profit. TTE could be used for trading of Ross Hook or 1-2-3 patterns.
Let's first see the use of TTE during the formation of a 1-2-3
bottom/top (Chart 65).
The classic entry is after the break of point 2. The initial stop should
be above/below points 1 or 3. Major market participants, however, know that
above this level could be clustered stop orders and they often take advantage
of this situation.
If you don't want to be a victim of the stop hunting, it is good to have
an open position before it is initiated. Formation of point 2 is completed
when we have the first corrective bar after the pullback from point 1.
When the trend resumes, we can not know whether a new lower low
will be reached or it will end higher than point 1 (1-2-3 bottom).
Nothing prevents us, however, from trying to "outsmart" a large part
of the other market participants.
We can try to open a position earlier with a stop order above the
maximum of each period during the price move from point 2 lower.
If the order is triggered we will have a long position. The initial stop
should be placed below the minimum of the period in which it was opened.
We should look for an entry until the third bar of the correction.
After this a ledge is forming, and this is a form of a consolidation.
The only exception to this rule can be made if there are two periods with the
same maximum (1-2-3 bottom) or minimum (1-2-3 top).
You can put an additional condition - the distance between the entry
level and point 2 should cover the stop. It will be better if the ratio between
them is at least 2:1.
This is very important for the money management.
If we open a position with the use of TTE when 1-2-3 bottom is
forming, we will have the advantage to close 1 or 2 parts before the test of
point 2.
The stop could be moved to break even and the risk would be
covered. It all depends on the specific position management rules we apply.
If large funds have decided to activate the stops just above point 2 and
resume the downtrend, in most cases can end up with a small profit.
However, if it is really a 1-2-3 pattern, we will have a long position at
the beginning of an uptrend or short at the beginning of a downtrend. With
the proper position management the results could be much better than
expected.
ТТЕ at 1-2-3 bottom

Chart 65
When we trade a breakout of a Hook Ross it is also better to use the

TTE instead of the standard rules.
In this case we open a position before most of the other traders and
the initial stop will be considerably smaller. On Chart 66 the currency pair
USD/JPY is in an uptrend. The upward price move stops at some point and
the first candlestick with a lower maximum creates the Ross Hook. It is not
good to look for entry after the first candlestick of the pullback, as the
distance to the last swing high is very small compared to the initial stop.
In general, the faster the initial price move resumes, the stronger the
trend is. Unfortunately in this case it is less likely to have sufficient distance
to the Ross Hook that covers the stop.
In the example on Chart 66 the second candlestick is not appropriate,
but on the third we can put a stop order to open a long position at 99.88. The
signal candlestick is a reversal pattern, which further increases the probability
for success. The upward price move resumes and we have a long position.
The initial stop is below the minimum of the signal candlestick at 99.79 (9
pips).
This is not so bad especially if you compare it with the option to open
the position after the breakout of the Ross Hook.
In this case the entry should be at 99.96 with initial stop of 17 pips.
Almost twice as large. Three periods after we bought, the currency pair
breaks above the Ross hook. The upward price move accelerates after the
stops above the figure (100.00) are hit. We can close part of the position just
before the test of the Ross Hook to cover the stop.
ТТЕ

Chart 66
Joe Ross has written a lot of books and who is interested can get
acquainted with his style of trading in detail.
Now I want to emphasize on what I have learned from Joe Ross.
The first thing is that there is no reason to complicate both the
analysis and the trading system.
Very simple methods explain everything and allow us to understand
what is going on in the market.
Another important thing is that large market participants initiate price
movements that activate stops and result in false breakouts.
This, however, is a fact that we can not change and must only comply
with it. What we can do is to open positions before most of the traders have a
set up and when they begin to buy or sell, we can take partial profits and
move the initial stop.
This is the most important principle in my trading strategy.
Another important thing I borrowed from Joe Ross is to close the
position in 3 parts.
The first covers the risk (all or at least part of it) , the second gives
some profit, and the third follows the price movement. If my entry is at the
beginning of the trend, the third part can make substantial profits.
Al Brooks
There is no way to write about the price action trading and not
mention the name of Al Brooks.
When I learned about his style of trading, I had almost completely
built my system, but it is interesting to make a comparison between him and
Joe Ross.
They use almost identical methods for position entry as their trading
strategies are based on similar principles. Positions are opened during a
pullback in the direction of the trend. The entry is with a stop order
above/below the extreme of a signal bar.
The difference is in the setups they use to identify the signal bar. The
rules are simple, yet very efficient.
No complicated indicators or methods telling us that the market can
go up or down.
The other thing, which is extremely important, is that Joe Ross, and
Al Brooks often talk about the major market players' activities and give tips
on how we can protect ourselves and even how to use them in our favor.
I'll start with the chart settings used by Al Brooks.
He trades E-mini S&P500 futures on 5-minute Chart.
The only indicator on his chart is a 20-period EMA. Sometimes he is
using Fibonacci levels, but they do not play a significant role in hi strategy.
According to him, when the market is in consolidation, trading is not
recommended and absolutely forbidden for novice traders.
Equivalent of the TTE of Joe Ross are the High/Low 1, 2, 3, 4, and Al
Brooks defines them as follows (Al Brooks, “Reading Price Charts Bar by
Bar: The Technical Analysis of Price Action for the Serious Trader”, Wiley
Trading):
High 1, 2, 3, or 4 - A High 1 is a bar with a high above the prior bar in
a correction in an up or sideways market. If there is then a bar with a Lower
High (it can occur one or several bars later), the next bar in this correction
whose high is above the prior bar's high is a High 2. Third and fourth
occurrences are a High 3 and 4. There are other variations as well.
Low 1, 2, 3, or 4 - A Low 1 is a bar with a low below the prior bar in
a correction in a down or sideways market. If there is then a bar with a
Higher Low (it can occur one or several bars later), the next bar in this
correction which low is below the prior bar's low is a Low 2. Third and fourth
occurrences are a Low 3 and 4. There are other variations as well.
Al Brooks also recommends entries only in the direction of the trend
after a pullback. He prefers two leg pullbacks, as at the second attempt we
have better chances of success. It is better to buy after a High 2 in the uptrend
and Low 2 in a downtrend. This is little contrary to the requirement of Joe
Ross to open a position with TTE only if the correction is up to three bars.
Joe Ross relies on a strong trend, which resumes after a brief pullback, while
Al Brooks is looking for security with the second attempt.
Everyone has to decide which option is more suitable for him, and use
it every time. Otherwise, instead of trading you will be betting.
Al Brooks recommends the following conditions for an entry:
· Break of a major trend line (trend line that covers
most of the price action on the chart);
· Test of the extremum of the trend;
· Forming of Higher or Lower High/Low;
· Forming of a High/Low 1, 2, 3, 4.
If you learn to read the candlesticks and bars on your charts, follow
these simple rules, and apply strict risk management, you can be a successful
trader.
The problem with the rules is that no matter how simple and logical
they may be, they cannot be subject of their own observation.
If you do not have at least some discipline, it is better to find another
hobby. This one (trading) could be too expensive for you.
As I said Joe Ross and Al Brooks pay attention to the major market
players activities and give tips on how we can take advantage.
For this reason, I want to draw your attention to what Al Brooks calls
failure and failed failure. The definitions from his book are as follows:
Failure - A move where the protective stop is hit before a scalper's
profit is secured or before the trader's objective is reached, usually leading to
a move in the opposite direction as trapped traders are forced to exit at a loss.
Currently, a scalper's target in the Emini of 4 ticks requires a 6-tick move,
and a target in the QQQQ of ten ticks requires a 12 cent move.
Failed Failure - A failure that fails, resuming in the direction of the
original breakout. Since it is a second signal, it is more reliable.
These two set-ups have two features that are highly valuable:
After the Failure, one direction is rejected and it is reasonable to
expect that the price will go to the other. In trading it is good that there are
only two directions, and the quotes cannot stay at the same level forever.
With the Failed Failure the situation is even better. We have two unsuccessful
attempts and the price move resumes in the direction of the original trend.
In both cases, the price move gets good initial acceleration after stops
of the positions opened on the original signal are activated and the traders
move from one camp to the other. This is very valuable because we can close
part of the position very quickly and move the stop to break even. Dealing
with minimum stress is preferable and in any event will give us better results.
The problem with trading failures stems from the fact that traders are
looking usually for "real" signals to open a position.
Therefore, it is a bit difficult to get used to wait for other traders to
open their position and expect their failure.
Of course, after gaining sufficient experience, you will be able to
identify the conventional setup, wait for its failure and trade it.
On Chart 67, you can see an example of trading a failure. The chart is
with 1-minute time frame (Al Brooks trades on 5-minute), but I personally
prefer to apply creatively any rules depending on the situation.
It is extremely important for everyone to find a suitable time period.
The risk and profit target of every single position depends on this decision.
Financial markets are constantly changing and you cannot afford the
luxury to be too conservative.
In the example on Chart 67, EUR/USD is in an uptrend, which is
clearly visible from the sequence of higher highs (HH) and higher lows (HL).
A pullback begins and the candles form High 1 to High 4. Long entry
is activated by a break above the High 4. After the break, unfortunately for
the bulls, a reversal candlestick appears and the pair sharply turns in the
opposite direction.
In such cases, it becomes clear why Joe Ross requires the original
price move to resume not later than three periods.
To trade such failures we must have sufficient experience to identify
them quickly and place a stop order to sell below the minimum of the last
period. It is not very easy, but not impossible if we've done a good
preliminary work and have a plan.
Failure

Chart 67
Trading commodities and stock indices became more accessible with

the introduction of the Contracts For Difference (CFD).
These are actually financial derivatives based on an asset that enable
traders to profit or lose only from the price differences. They are not
standardized as futures contracts and do not require ownership of the asset,
which makes them accessible to a large number of traders.
For example, the margin for E-MINI S&P 500 futures is $3.850,
while CFD brokers will allow a position to be open for a much smaller
amount. Contracts for differences on stock indices are becoming a good
alternative to the forex and the example of Chart 68 is with CFD based on the
Dow Jones Industrial Average (brokers use different names for the CFDs on
the same underlying asset). The good thing about the stock market indices
and stocks is that they are trending very well, and the preferred direction is
upwards. This greatly facilitates the trading.
On Chart 68 the market has been in an uptrend and another correction
began. High 1 and High 2 appear and after a break above the latter a long
position is opened.
The initial stop is below the minimum of the signal candle.
Unfortunately, the uptrend is not resumed, and immediately a reversal candle
forms. Quotes go back down again and the protective stop is hit. The long
entry signal fails. Once the stops of the short-term traders are cleared, the real
upward price move may begin.
Formation of a hammer, shows that the bulls have not given up. The
failure fails and after three periods the previous high is broken and the
uptrend is restored. In such cases we must have a habit to look for failures
and to choose in advance which set up will trade.
We should be aware that the failure is against the major trend, while
the failed failure is in its direction. Once you know what you wait for, you
just need to create a habit to quickly identify it and quickly place the orders to
open a position with a protective stop.
Failed failure

Chart 68
Al Brooks describes two patterns that I use very often in my strategy

for trading.
Double bottom bull flag (Chart 69) is pause or flag during the
development of the bull trend, in which there are two spikes down to almost
the same level, and then the bull trend resumes.
Double bottom bull flag
Chart 69
Double top bear flag (Chart 70) is a pause or flag during the
development of a bear trend, in which there are two spikes up to almost the
same level, and then the bear trend resumes.
Double top bear flag
Chart 70
These two patterns are actually my best set-up for position opening.
Trading is to follow the big money, suggesting entries should be in
the direction of the main trend when the market is in a correction.
When the corrective price move stops somewhere and the quotes go
back in the direction of the trend, it is not accidental. Not at all!
The main reason usually is that a large market participant has started
again to buy (in an uptrend) or sell (in a downtrend).
Generally larger funds rarely do something at one step and once they
have started opening positions from one level it is likely they will continue to
do so.
Fighting against banks and funds is a losing game and it is much more
reasonable to follow them.
I would like to strongly emphasize that in trading it is all about
probabilities and there is nothing guaranteed. Our job is to assess the
probabilities and to trade in the direction in which they guide us.
I have no intentions of telling you all about the styles of trading Al
Brooks and Joe Ross, as they are explained very well in their books.
I recommend these books to anyone who wants to trade at the
financial markets. What you have to remember from Joe Ross is that you
should trade in the direction of the trend and open your position during a
correction.
The rules of your trading system should be simple, but should point
the exact levels for entry and initial stop.
It is advisable that your position is closed in several parts. It does not
matter if you choose to do it in two parts as Al Brooks suggests, or in three as
Joe Ross does.
The important thing is you always to do the same, and not to
experiment constantly. There is a huge probability to choose only the losing
options. Prices of the financial instruments are driven by the major market
participants, and therefore it is better to know their actions and follow them
when possible.

02-Forex Price Action Explained-Svetlin Minev

Uploaded by

Document Information

Original Description:

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

02-Forex Price Action Explained-Svetlin Minev

Uploaded by

Copyright:

Available Formats

For more FREE Ebooks, strategies and materials you can visit:

PRICE ACTION BASICS

STATISTICS AND FOREX

HOW TO READ THE CANDLESTICKS

“An investment in knowledge pays the best interest.”

Trading is a zero sum game.

Source: MetaQuotes Software Corp.

Source: Metaquotes Software Corp.

Source: Metaquotes Software Corp.

Source: Metaquotes Software Corp.

When speaking of moving averages, it always logically arises the

Source: Metaquotes Software Corp.

Source: Metaquotes Software Corp.

I left my favorite support and resistance levels for dessert.

Source: Metaquotes Software Corp.

Source: Metaquotes Software Corp.

Source: MetaQuotes Software Corp.

Determining the trend with moving averages

Source: MetaQuotes Software Corp

Types of entries around moving averages

Source: MetaQuotes Software Corp.

· False breakout and a return above the moving

Source: MetaQuotes Software Corp.

Source: MetaQuotes Software Corp.

Double or triple bottom on a tick chart

Quote reading entry

Source: Metaquotes Software Corp.

Source: Metaquotes Software Corp.

Source: Metaquotes Software Corp.

Chart 78 shows an example of a head and shoulders of GBP/USD on

Source: Metaquotes Software Corp.

Source: Metaquotes Software Corp.

Source: Metaquotes Software Corp.

Let's see in detail the situation presented on Charts 26 and 27.

Source: Metaquotes Software Corp.

Source: Metaquotes Software Corp.

Range = Maximum value – Minimum value

Because sometimes the market opens with a price gap, it could be

Source: MetaQuotes Software Corp.

Another statistical measure of volatility, that we can use, is the

Source: MetaQuotes Software Corp.

Unfortunately, these two volatility indicators are not used by many

The most valuable characteristic of volatility is that it is cyclical, i.e.

Source: MetaQuotes Software Corp.

Source: MetaQuotes Software Corp.

Correlation on daily basis

Source: www.mrci.com Chart

Source: MetaQuotes Software Corp.

Source: MetaQuotes Software Corp.

Reversal patterns can also consist of more than one candle.

Source: MetaQuotes Software Corp.

Source: MetaQuotes Software Corp.

If the quotes have to go from 1.3144 to 1.3145, someone has to buy

Source: MetaQuotes Software Corp.

Source: MetaQuotes Software Corp.

In my previous book I discussed the topic of stop hunting that major

Accordingly, in a downtrend the market reaches a new swing low

Source: MetaQuotes Software Corp.

Source: MetaQuotes Software Corp.

Source: MetaQuotes Software Corp.

When we trade a breakout of a Hook Ross it is also better to use the

Source: MetaQuotes Software Corp.

Source: MetaQuotes Software Corp.