Archive for the ‘Forex Indicator’ Category

Chikou Span Cross

December 4, 2008

For those that have been using the Ichimoku Kinko Hyo charting system for any length of time, utilizing the chikou span cross strategy should be like second nature. Why? Because the chikou span cross is essentially the “chikou span confirmation” that savvy Ichimoku traders utilize to confirm chart sentiment before entering any trade. This confirmation comes in the form of the chikou span crossing through the price curve in the direction of the proposed trade. If it crosses through the price curve from the bottom up, then it is a bullish signal. If it crosses from the top down, then it is considered a bearish signal.

Thus, we already know the power of the chikou span cross via its use as a confirmation strategy. However, when used within some simple guidelines, the chikou span cross can be used as its own standalone trading strategy with very good success.


Like many other Ichimoku trading strategies, the chikou span cross strategy uses price’s relationship to the kumo to categorize its signals into three (3) major classifications: strong, neutral and weak.

STRONG CHIKOU SPAN CROSS SIGNAL

A strong chikou span cross Buy signal takes place when a bullish cross takes place and current price is above the kumo
A strong chikou span cross Sell signal takes place when a bearish cross takes place and current price is below the kumo.

NEUTRAL CHIKOU SPAN CROSS SIGNAL

A neutral chikou span cross Buy signal takes place when a bullish cross takes place and current price is within the kumo
A neutral chikou span cross Sell signal takes place when a bearish cross takes place and current price is within the kumo.

WEAK CHIKOU SPAN CROSS SIGNAL

A weak chikou span cross Buy signal takes place when a bullish cross takes place and current price is below the kumo
A weak chikou span cross Sell signal takes place when a bearish cross takes place and current price is above the kumo.

The chart in Figure IX below provides several examples of the chikou span cross. Given the fact that the chikou span is a measure of closing price shifted 26 periods into the past, we must always keep in mind both the location of the chikou span in relation to the price curve (the “cross” itself) and the current candle and its relation to the kumo. Thus, Point A1 is the point where the chikou span crossed the price curve downward and Point A2 is the closing candle that initiated that bearish cross. However, since the candle at Point A2 was above the prevailing kumo at the point of the cross, this particular signal would be categorized as a “weak” bearish cross. A strong bullish cross can be seen in Points B1 and B2 since the chikou span crossed upward through the price curve and the closing candle at that point in time was above the prevailing kumo. Points C1 and C2 represent a weak bearish cross given that they transpired above the prevailing kumo.

FIGURE IX - Chikou Span Cross Classifications

Entry

The entry for the chikou span cross is relatively straightforward – the trader initiates a position in the direction of the chikou span cross after taking into consideration the cross’s strength and other chart signals. For the highest probability of success, the trader will also look for the chikou span itself to be free of the kumo as the chikou span can often interact with the kumo much like the price curve.
Exit

The most traditional exit for a chikou span cross trade is generally signalled by a chikou span cross in the opposite direction of the trade, though other exit signals may be taken depending upon the trader’s risk tolerance and profit goals.
Stop-Loss Placement

The chikou span strategy does not dictate use of any particular Ichimoku structure for stop-loss placement, like some other strategies do. Instead, the trader should consider their execution time frame and their money management rules and then look for the appropriate prevailing structure for setting their stop-loss.
Take Profit Targets

Take profit targetting for the chikou span cross strategy can be approached in one of two different ways. It can be approached from a day/swing trader perspective where take profit targets are set using key levels, or from a position trader perspective, where the trader does not set specific targets but rather waits for the current trend to be invalidated by a chikou span cross transpiring in the opposite direction of their trade.
Case Study

In the Daily chart in Figure X below for USD/CHF we can see a bullish chikou span cross at point A. However, while it is technically a strong cross, the chikou span is still below significant resistance provided by the two chikou span points at 1.2090. In addition, the tenkan sen and kijun sen are in a flat configuration which doesn’t provide any additional confirmation. Thus we wait for a more convincing setup before entering Long. This is achieved five (5) days later at Point B1 when the chikou span moves back up through the price curve after a brief dip below. We wait for the daily candle to close and then enter long at 1.2164 at Point B2. Our confidence in this entry is increased by the bullish tenkan sen/kijun sen cross that has since transpired.

For our stop-loss, we consider the prevailing structures and decide to place it just below the kijun sen at 1.1956, since a cross below that point will not only have the chikou span executing a fresh bearish cross, but also have price executing a bearish kijun sen cross, both of which would invalidate our long position.

Once we place our entry and stop-loss orders, we wait for the trade to unfold. Depending upon our trading style, we could opt to trail our stop-loss along with the kijun sen to keep a tighter rein on risk management or we could utilize the more traditional method of waiting for a chikou span cross in the opposite direction of our trade. In this case, a chikou span cross in the opposite direction takes place just under two months later (Point C1) at 1.2619 (Point C2) and we close out our trade for a gain of over 450 pips. It is worth noting that, even though the chikou span cross on its own would be considered technically “weak” due to its location above the kumo, it is bolstered by a bearish tenkan sen/kijun sen cross to form a bearish three-line pattern. Alternatively, if we had chosen to use the kijun sen as our trailing stop in this trade, instead of waiting for a chikou span cross, we would have exited somewhere around the 1.2735 level, which would have netted us over 560 pips.

FIGURE X - Chikou Span Cross Case Study

Tenkan Sen/Kijun Sen Cross

December 4, 2008

The tenkan sen/kijun sen cross is one of the most traditional trading strategies within the Ichimoku Kinko Hyo system. The signal for this strategy is given when the tenkan sen crosses over the kijun sen. If the tenkan sen crosses above the kijun sen, then it is a bullish signal. Likewise, if the tenkan sen crosses below the kijun sen, then that is a bearish signal. Like all strategies within the Ichimoku system, the tenkan sen/kijun sen cross needs to be viewed in terms of the bigger Ichimoku picture before making any trading decisions, as this will give the strategy the best chances of success.

In general, the tenkan sen/kijun sen strategy can be classified into three (3) major classifications: strong, neutral and weak.

STRONG TENKAN SEN/KIJUN SEN CROSS SIGNAL

A strong tenkan sen/kijun sen cross Buy signal takes place when a bullish cross happens above the kumo.
A strong tenkan sen/kijun sen cross Sell signal takes place when a bearish cross happens below the kumo.

NEUTRAL TENKAN SEN/KIJUN SEN CROSS SIGNAL

A neutral tenkan sen/kijun sen cross Buy signal takes place when a bullish cross happens within the kumo.
A neutral tenkan sen/kijun sen cross Sell signal takes place when a bearish cross happens within the kumo.

WEAK TENKAN SEN/KIJUN SEN CROSS SIGNAL

A weak tenkan sen/kijun sen cross Buy signal takes place when a bullish cross happens below the kumo.
A weak tenkan sen/kijun sen cross Sell signal takes place when a bearish cross happens above the kumo.

See the chart in Figure I below for an example of several classifications of the tenkan sen/kijun sen cross:
FIGURE I - Tenkan Sen/Kijun Sen Cross Classifications

But wait! Have you checked the chikou span?

With these three major classifications in mind, we will add something else into the equation – the chikou span. As we explained in the section detailing the chikou span, this component acts as a “final arbiter” of sentiment and should be consulted with every single trading signal in the Ichimiku Kinko Hyo charting system. The tenkan sen/kijun sen cross is no different. Each of the three classifications of the TS/KS cross mentioned above can be further classified based on the chikou span’s location in relation to the price curve at the time of the cross. If the cross is a “Buy” signal and the chikou span is above the price curve at that point in time, this will add greater strength to that buy signal. Likewise, if the cross is a “Sell” signal and the chikou span is below the price curve at that point in time, this will provide additional confirmation to that signal. If the chikou span’s location in relation to the price curve is the opposite of the TS/KS cross’s sentiment, then that will weaken the signal.
Entry

The entry for the tenkan sen/kijun sen cross is very straightforward – an order is placed in the direction of the cross once the cross has been solidified by a close. Nevertheless, in accordance with good Ichimoku trading practices, the trader should bear in mind any significant levels of support/resistance near the cross and consider getting a close above those levels before executing their order.
Exit

The exit from a tenkan sen/kijun sen cross will vary with the particular circumstances of the chart. The most traditional exit signal is a tenkan sen/kijun sen cross in the opposite direction of your trade. However, personal risk management and time frame concerns may dictate an earlier exit, or an exit based upon other Ichimoku signals, just as in any other trade.
Stop-Loss Placement

The tenkan sen/kijun sen strategy does not dictate use of any particular Ichimoku structure for stop-loss placement, like some other strategies do. Instead, the trader should consider their execution time frame and their money management rules and then look for the appropriate prevailing structure for setting their stop-loss.
Take Profit Targets

Take profit targetting for the tenkan sen/kijun sen cross strategy can be approached in one of two different ways. It can be approached from a day/swing trader perspective where take profit targets are set using key levels, or from a position trader perspective, where the trader does not set specific targets but rather waits for the current trend to be invalidated by a tenkan sen/kijun sen cross transpiring in the opposite direction of their trade.

Case Study

In the 4H chart in Figure II below we can see a bullish tenkan sen/kijun sen cross at point A. Since this cross took place within the kumo itself, it is considered a “neutral” buy signal, thus we wait for price to exit and close above the kumo to confirm this sentiment before placing our long entry. Price does achieve a close above the kumo at point B (1.5918) and we place our long entry at that point. For our stop-loss, we look for the place where our trade sentiment would be invalidated. In this case, the bottom edge of the kumo provides us with just that at point C (1.5872).

Once we place our entry and stop-loss orders, we merely wait for the trade to unfold while keeping an eye out for potential exit signals. Price rises nicely for the next 10 to 11 days and then, on the 15th day of the trade, price drops enough to have the tenkan sen cross below the kijun sen at point D. This is our exit signal, since Ichimoku is telling us that the sentiment has changed, so we close our order at 1.6014 at point E for a total gain of over 95 pips.

FIGURE II - Tenkan Sen/Kijun Sen Cross Case Study
For maximum risk management on this trade, we also could have moved our stop-loss up with price once price was a conservative distance away from our entry. One option for doing this would be to move the stop-loss up with the kumo, keeping it just below the bottom edge. For even tighter risk management, we could have moved our stop-loss with the kijun sen, keeping it 5 to 10 pips below that line as it moved up.

Relative Strength Index (RSI) strategy

December 1, 2008

Hi, this is Ty Young with Surefire-trading.com and today I will be discussing the Relative Strength Index (RSI).

History

J. Welles Wilder, Jr., a contemporary technical analyst, is well noted for his accomplishments as the designer of several technical indicators. Though the simplest of these to understand is the RSI oscillator, it is hardly the least in importance to the committed trader. In fact, next to the Bollinger Bands, this is a tool that I reach for most often. Though Wilder’s indicators were intended to function as “stand-alone” systems, I find greater confidence in using them as confirmation triggers. I never place my complete trust in any single indicator.

Technical

Wilder describes the RSI, along with his other indicators, in his book, “New Concepts in Technical Systems”.

The RSI is quite simple in its construction, calculated as follows:

100
RSI = 100 – ___________________________
1+ (Average Gain / Average Loss)

However, every major charting service I have viewed calculates the formula for us.

Primarily, the RSI measures the internal strength (by comparing the current price against the average price – thus the term “Relative Strength”) of any given security (or in our case, currency) providing awareness to overbought (OB) and oversold (OS) conditions, as depicted on a scale of 0 – 100.

Generally, the rule of thumb is – when price rises above an RSI level of 70, it is considered to be OB; and below 30 is considered OS. Now, this is not to say that when the RSI rises above 70 that it is time to sell; nor, is it time to buy when it drops below 30 since markets can remain in OB/OS conditions for extended periods of time.

Also, because the RSI often leaves OB/OS territory and immediately crosses back into those levels, we want to exercise extreme caution when trading such signals.

In addition to the 30 and 70 RSI levels, the 50 RSI level is equally vital to interpreting the chart. Above the 50-line is generally considered bullish, whereas, below the 50-line is generally considered bearish.

Also, remember, the RSI is a lagging indicator; in other words, it follows the price (the price moves, then the indicator follows – it is NOT predictive). Despite popular opinion, we are not ‘fortunetellers” and there is NO crystal ball; so we must use other means to trigger our entries.

In the last lesson entitled “Bollinger Bands”, we briefly made mention of two methods of using the RSI as confirmation. Let’s delve into these a bit deeper. One of the most ideal ways is to look for divergence; the price rises to a new high, whereas, the RSI fails to break its previous high (bearish). Conversely, when price makes a new low, subsequently, the RSI fails to break its previous low (bullish). Divergence provides us with a signal that may lead to a reversal or merely a correction (be it ever so slight); also known as a retracement.

Another method is a RSI trend line break that corresponds to a trend line break (and subsequent close) on the price chart.
And the RSI can also be used for a “breakout” strategy, as well.

So, let’s take a look at some examples.

Charts
In using the RSI as a signal for OB/OS conditions, one practice, which is often taught among traders, is to watch for the RSI to cross into OB/OS territory. Once the RSI moves out of OB/OS territory, we have an opportunity for a possible entry. If done correctly, this method can be profitable – however, it can be a very dangerous means of trading if acted upon too presumptuously. And here’s why.

As we look between the two vertical red lines on the 60-min. Euro chart below, we see that the price moved from a low of 1.5254 to a high of 1.5421 – a rise of 167 pips, while the RSI continued to whipsaw numerous times across the 70-line and back again. Had we entered a short position when the RSI initially crossed above the 70-line, we would have unnecessarily placed ourselves in harms way; likewise, had we taken a position immediately following the subsequent cross below the 70-line (believing the bullish move to be completed), the results would have been equally devastating.

relative strength index

If you are trading Forex (e-minis), a 167 pip correction in the market is not a terrible risk, however, if you are trading Currency Futures (at $12.50/tic/contract), a 167 tic correction could be costly if the market does not follow through.

Taking another look at this same chart (below), we see that the Euro continued to fail in its attempt to reverse for an additional 482 pips, providing a crushing blow to the bears totaling 649 pips before making a defined reversal – now, as a Futures trader, a mistake like that could unnecessarily deplete your trading account immensely.

rsi

Right about now you may be thinking, “What are you trying to do, Ty, scare me?” Yes, I am. This is a business – it is not a game. If you want a game, go to the casino. My purpose is to provide you with a healthy respect for the markets. And provide you with the tools needed to succeed in this business. If you disrespect the markets by means of ignorance, laziness, or a basic “nonchalant” attitude, this beast will chew you up, swallow you whole – and not even choke………………and sleep like a baby when the bell rings.

To combat the fatal error depicted in the previous example there are a number of things that can be done. First and foremost, stay with the trend (which we will discuss later in this lesson). Second, practicing wise money management is a must; making sure your stops are in place. Also, using different settings like 80/20 can also be helpful. Experiment with the different settings and see which ones provide you with the greatest profits (and protection) for the particular time frame that you are trading.

Reversals and Retracements

Remember our definition of divergence; the price rising to a new high, whereas, the RSI makes a new low (bearish). Conversely, when price makes a new low, subsequently, the RSI makes a new high (bullish). Take note; the price trend line and the RSI trend line must be drawn relative to each other as depicted by the two vertical red lines. Remember – compare apples with apples.

In this 4-hr. chart, initially, we take notice of the fact that the price has indeed made a new high, as depicted by the upward sloping trend line (1) while the corresponding RSI trend line (2) is sloping downward indicating that the last RSI reading between the vertical red lines is lower than the initial RSI reading. This tells us that the bulls are weakening. What gives greater credibility to this sell signal is the fact that when the RSI pulled back (to the shaded area), it did not cross above the 70-line – it remained below the 70 level.

So, in summary, in the chart below, the price closed higher than the previous high, whereas, the RSI reversal signal began its formation above the 70 level and divergently moved to a position lower than the previous high.

forex

Once again, let’s look at the same chart where I have added trend lines (TL); two on the price chart and one to the RSI indicator. On the price chart, there is a primary TL and a secondary TL. The primary bullish TL designates the initial trend, however, we see that the price suddenly breaks away from the TL and moves aggressively in the same direction as the trend – providing us with a trend within a trend, designated by the secondary TL (and an opportunity for an early entry). The break to the bearish side of both the secondary TL on the price chart and a break to the bearish side of the RSI indicator provide us with additional confirmation that the bears are taking control.

FX

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Trade Example

So, let’s take a look at some various ways we could trade this chart.

  • First of all, price action is always my first concern and there is nothing that I like better that provides a visual perspective than the Bollinger Bands; so they are always on my charts.
  • Secondly, I take notice that we have a classic Bollinger Band reversal signal indicating that the bulls may be losing control – so I look for confirmation.
  • I receive the first confirmation with RSI divergence. Not completely satisfied – I wait for a second confirmation, which is provided to us with the trend line break and subsequent close.
  • As candle (1) begins to fall, I take notice of the fact that the RSI (having broken the RSI trend line to the bearish side) has pulled back to the shaded area without crossing above the RSI trend line.
  • As an aggressive trader, I would then place a Sell/Stop order (“sell at the market” if the price action is moving too swiftly) at the low of candle (2). A conservative entry would have been placed at the low of candles (3) or (4).
  • With a close outside the lower Bollinger Band, I have confidence that the bears are in control so, as candle (5) retraced to the trend line (take note that a candle (5) entry only has credibility because of a price close below the lower band and the RSI has continued to fall below the 50-line) I would then add to my position.
  • Immediately upon entering the market at any of the levels, my stop/loss would be placed a few pips above candle (1).
  • With the subsequent BB reversal signal (candle formation 7), I begin to protect my profits with a trailing stop.

technical analysis

Trending Markets

We have just seen how the RSI and trend lines can help take advantage of a reversal or retracement opportunity.

But what about using the RSI in order to stay with the trend longer – “letting our profits run”?

Let’s take a look.

In the 4-hr. chart below, let’s assume we have entered the market at candle (1) with a bullish position on the break of the price trend line along with the break of the RSI trend line with a subsequent cross of the 50-line; we are long.

trending markets

In the chart below, the Bollinger Bands provides confirmation to the price action as long as the price does not close below the lower band. Each time the market breaks the lower band (without a close) and returns upward, we protect our profits by moving our stops (red horizontal lines) to a position just below the candle that broke outside the band.

forex system trading

Added (or instead of the BB) confirmation is provided by the fact that the RSI (shaded area below) has predominantly remained above the 50-line at each retracement of the price. Each time the RSI moves toward the 50-line and subsequently returns to the 70 level, we move our stops to a position just below the candle that corresponds with the RSI in order to protect our profits – and remain in the market.

trading signal

In this 4-hr. Euro chart, the close below the lower BB just happened to coincide with the break of the RSI 50-line (Good call).

More on Trending Markets

Let’s briefly discuss this concept of “trading the trend” in relationship to the RSI. Earlier I stated the time frame chosen varies with our different trading styles – or that which we are most comfortable. Primarily, this is determined by your personality and the size of your trading account. However, the chart that first provides us with an entry signal also determines what time frame we will trade. In other words, if we get a entry signal on the 60-min. chart, that’s the chart we trade; the 4-hr. chart, then the 4-hr. chart……and so forth.

In the previous 4-hr chart where I stated, “let’s assume we have entered the market at candle (1)”; let’s see why I chose that time frame? We had an entry signal – a break of the price trend line and a coinciding break of the RSI trend line. But how did I know that that break would have me “trading with the trend”? Take another look at the 4-hr. chart. From this chart (prior to the break upward), can you tell what the trend is?

charts

Of course not. But if I move up a time frame to a Daily chart, what do you see?

day trading

Not only do we have an obvious visual confirmation to the price trend but also we see that within the RSI each low is higher than the previous low – and heading toward the 50-line. My entry on the 4-hr chart was in-line with the trend on the Daily chart. Let’s look at another chart.

In the 15-min. chart below, we have a TL break and subsequent close and a RSI break, which takes it above the 50-line. Bullish right? But am I really entering with the trend? Frankly, we can’t tell from this chart either, can we?

forex trading

But if I go up to a 30-min. chart……now what do you see?

trend trading

The 30-min chart shows us that we are indeed with the greater trend – while at the same time, the RSI is heading for bullish territory. I can enter on the long side on the pullback to the price TL because the RSI is still above the 50-line and heading north.

OK, one more example.

bullish divergence

In this 1-hr. chart above we have a classic BB reversal signal, a nice little reversal doji (shaded area – but that’s for later), bullish divergence, and a trend line break on the price chart coinciding with a RSI trend line break and a RSI that has multiple higher lows. Awesome confirmation – what more can a trader ask for!!! I am so ready to jump in on the bullish side. But wait – let’s take a peek before we leap – at the 4-hr. chart…..….. :o)

down trend

You still want to enter the market with a long order? I think not. Stay with the trend – stay within your comfort zone; take a step up one time frame and get the bigger picture.

Breakouts

Up till now we have primarily been dealing with trending markets. Someone asked me the other day, “What about “range-bound” markets? Well, let’s take a short look at a range-bound market. You will find that many of the guidelines given so far (including those which apply to the Bollinger Bands) still apply; i.e., BB Reversals & Trend continuation, divergence, and trend line breaks. However, here’s a small tidbit to add to your toolbox, which can offer us greater confidence in either continuing with the trade or making an initial entry.

Looking at the 4-hr. chart below there is an apparent range-bound market, which had continued for several months with a subsequent breakout to the bullish side. Was there a signal that was definable at that breakout?

breakout trading

In order to answer this question, let’s look at a previous break of the high. Candle (2) broke higher than candle (1). Many would have been quick to have a “buy/stop” order waiting at the break of candle (1) merely because it is an area of resistance -only to have a failed trade – why? What is the RSI (3) formation called? Divergence. Not a good place to buy. However, when candle (4) broke higher than candle (2) at the same area of resistance, what did the RSI do? It broke above the 70 level….BINGO!
A nice place to buy. And confirmed by a close outside the upper BB – giving us a nice conservative trade.

However, being an aggressive trader, when RSI (5) broke below the 30 level with the coinciding candle (6) failing to break the previous low (7), I would have been looking for an opportunity to go long. Which I would have found as the RSI and price broke the coinciding trend lines – 459 pips earlier than entry (4).

Well, there you have it. There are other aspects of the RSI that are not within the limitations of this lesson but as you gain experience with the Relative Strength Index, you will begin to notice chart formations and support and resistance levels within the RSI that may not appear on the price chart – increasing the RSI’s potential.

With Surefire-trading.com, this is Ty Young, reminding you to “Read the Charts”. :o)

Ty Young
surefire-trading.com

Moving Average Convergence/Divergence (MACD)

December 1, 2008

Hi, this is Ty Young with Surefire-trading.com and today we will be discussing the Moving Average Convergence/Divergence (MACD).
Originally, Gerald Appel’s MACD was composed of a default setting (12,26,9) which displayed two lines. One line, the MACD, is the difference between the 26-period EMA and the12-period EMA. When an additional EMA (signal line, also known as the trigger line) such as the 9-period EMA is added to the mix, we have an indicator that reveals over bought (OB) and over sold (OS) conditions as well as providing us with buy/sell signals. This is accomplished through divergences or crossovers.

The general rule of thumb is, when the MACD rises above the signal line the bulls are in control. And conversely, when the MACD drops below the signal line, we look for an opportunity to sell. Greater credibility is given to the bulls/bears when the two lines cross above/below the zero line – conservatively speaking.

I say this because often times at OB levels, depending on support and resistance (S/R), Bollinger Band Reversal signals, Fibonacci, etc., the MACD can make a bearish cross (or in the case of the MACD Histogram – a bearish drop) giving great shorting opportunities despite the fact the MACD is way into bullish territory – the opposite being true for OS levels.

Knowing that lagging indicators can remain in OB/OS conditions for extended periods of time it is important to take note that these crossings provide us with potential entry signals; higher probability opportunities dictate that we look to other means for confirmation.

An added bonus is provided to us through the MACD Histogram, which gives us a visual perspective of the difference between the MACD (the difference of two EMAs) and the third EMA (signal line).

As with any oscillator, the MACD or MACD Histogram can provide us with possible retracement or reversal opportunities when divergence is visable.

Charts

In trading the Forex and currency markets, if you are more of a position trader, in order to limit whipsawing you will find it advantageous to use the standard MACD setting of 12,26,9 or longer. As an intra-day trader, I have deviated from the default settings by shortening the moving averages (10,22,5) in order to provide a more responsive indicator.

On the 4-hr. chart below, as the market began to drop we can see with Crossover (A), the MACD (blue line) moved below the signal line (red). In Crossover (B), as the price began to rise, the MACD moved above the red line. As the trend began to strengthen (bullish or bearish), the MACD pair crossed the centerline.

Also, take notice of the widening of the two lines. As with the Bollinger Bands, when the two MACD lines begin to widen or spread apart, this shows greater control of the dominant team (bulls/bears).

macd

In the next chart, we have the MACD Histogram, which is contrastingly portrayed as bars. Similar to the MACD above, however, we see below that the bars of the Histogram cross the centerline as domination of one group weakens while the other group strengthens. In contrast to the MACD lines crossing, however, as the trend strengthens/weakens the bars increase/diminish in size.

In other words, as the bulls’ position weakened the bars not only diminished in size, they crossed below the centerline. Having crossed the centerline into bearish territory, as the bears take greater control of the market, the bars once again began to increase in size – which is nothing more than the equivalence of the MACD lines widening.

moving average convergence divergence

Now, when we put the two indicators together (below), we can easily see the relationship between the MACD lines and the MACD Histogram. The Histogram is on the bullish side of the zero line when the MACD (blue) is above the signal line (red) – and on the bearish side of the zero line when the MACD is below the trigger line.

forex charts

Now, some charting services do not permit you to display the MACD as two distinct lines. As with the chart below, the MACD is displayed as a histogram (not to be confused with the MACD Histogram) and a signal line. Plainly stated, the two MACD lines have been substituted with histogram bars.

Instead of two lines (the MACD and signal line) crossing each other, the signal line crosses the histogram. So, we have three ways to determine dominance:

• The crossing of the histogram and the signal line (or, if you prefer, the crossing of the MACD and the signal line)
• The size (or length) of the bars (or, the widening of the red and blue lines)
• Above or below the zero-line.

trading

Basically, we have the same information provided with each – just a little different perception. So, if you have a choice, what it really amounts to is (from your perspective) which picture clearly depicts what is happening with the price action – which version of the MACD speaks the loudest to you.

We have now seen that the MACD is “merely” a combination of several EMAs either converging with each other or moving away divergently from each other at some point – thus the description, “Convergence/Divergence” – which raises the question, “Why not just place a 12 EMA and a 26 EMA (standard settings) on the price chart?” If you want to experiment a little, you will notice that the MACD doesn’t lag anywhere near as much as an EMA crossover – the MACD moves faster. And in our business a faster indicator is always a plus. This is precisely why I DO NOT use EMA crossovers to enter or exit the market; if you haven’t figured it out by now, you will see in time that MAs are best used for support and resistance.

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So, what do you say boys and girls – let’s trade.

Trade Example

In this 4-hr. chart bellow, as usual, the BBs provide us with the initial signal. What do we see?

1) In the boxed-in area (A), we have an opportunity to short the market with our classic BB reversal signal; demonstrated by a close above the upper band, subsequently followed by multiple closes within the bands.
2) The MACD is beginning a bearish cross.
3) And it is positioned in overbought territory. Shorting this market looks good doesn’t it?

Is this a “high-probability” trade?

Are we able to make a determination by this chart?

technical analysis

Remember, in order to get a clearer perspective, what is our first move? If this is, in-fact, a shorting opportunity – don’t we need confirmation of the trend? And we do this how? Or better asked, “Where?” Let’s go one time frame higher to the Daily chart.

What do we see?

forex

1) We have a bullish trend
2) We have consolidation (market is ready for a breakout)
3) MACD has made a bullish cross
4) MACD has broken above the zero line into bullish territory

So, let’s expand the Daily chart in order to get an even greater perspective.

FX

Now, what do we see?

1) Consolidation is obvious.
2) We have two closes above the upper band
3) And MACD indicates that the bulls dominate

Are we still looking for an opportunity to short this market?

NOT……………

We are looking for an opportunity to enter in a bullish direction. This would be a high probability trade.

Remember, we buy the dips and sell the rallies. So, if we are looking to go long, we are looking for what, specifically? A retracement. So, let’s go back to the 4-hr. chart and wait for a pullback.

pullback

  1. The market has pulled back to the 20 SMA
  2. MACD has crossed but remains in bullish territory

this is a good place to start. We will now drop down to a 60-min. chart to find our entry.

forex system trading

In the chart above, we see that we have a reversal signal; so, let’s pinpoint the entry.

entry point

In the chart above, we have an aggressive entry at the BB Reversal signal or we can enter more conservatively a few pts. above candle (C) – placing our protective stop, immediately below candle (D) or below the lower Bollinger Band.

As the price began to move in our favor (below), a trailing stop would move upward just below the lower BB….just as long as the MACD remained in bullish territory.

trading signals

A Classic BB Reversal signal confirmed with a crossing of the MACD (below) brings my stop higher – or conservatively, I could exit at this point.

bollinger band reversal

The next two hours prove, once again, the importance of protective stops (below). If you had not followed the market with a trailing stop, you would have exited at your original stop – with a loss…. a minor loss, non-the-less, a loss. As it is, sound-trading tactics provided us with a profitable day.

protective stops

Now, when it comes to trading divergence, my personal preference is the MACD Histogram. The chart below is where we originally entered the market – except I have exchanged the MACD indicator for the MACD Histogram. As you may be able to see, in addition to the BB Reversal signal, we have great bullish divergence.

bullish divergence

With Surefire-trading.com, this is Ty Young, reminding you to “Read the Charts” :o)

Bollinger Bands

December 1, 2008

Introduction

Hi, my name is Ty Young with http://www.surefire-trading.com. And as the newest member of the team, I would like to take a moment to introduce myself.

I am a Technical Analyst. This means, as a trader, it is my position that all action and reaction of the markets – all the fundamentals – are exclusively expressed within the charts. I am NOT saying that there is no place for the fundamentals, I am saying that the fundamentals determine the price – and the price dictates the technical data. So, we allow the price to determine our direction.

It is my goal, here at Sure-fire Trading; to assist you in developing the skills required to become a successful trader.

It is my goal to teach you how to analyze the charts – to teach you how to recognize “High Probability” trades.

As traders, what we do is a blending of chart mechanics and art. I will provide you with the mechanics portion; however, through experience and hard work, you must develop the artistic side of trading. Then and only then will you be able to tame the beasts that haunt every trader – FEAR and GREED.

It is my intention to provide you with the tools that will enable you to trade with CONFIDENCE. So, in the lessons to follow, repeatedly, my emphasis will be – “READ THE CHARTS.” If you hear me say it once, you will hear me say it a million times, “READ THE CHARTS”.

We are not fortunetellers. We are not in the business of predicting the direction of the market. We do, however, interpret the data provided to us by the charts – we then, trade accordingly. When the charts say buy – we go long. When the charts say sell – we short the market. If it’s not saying a thing – we do not trade. PERIOD. So, having said all that, let’s talk a bit about Bollinger Bands.

History

One of my most favorite indicators is the Bollinger Bands. Deriving its name from its founder, John Bollinger takes advantage of price action and volatility to create a picture that helps define the highs and lows of the market. And can even identify reversals within the market.

Like all innovative tools, they find their heritage in the successes and failures of those who have gone before them. John Bollinger, has developed an indicator that has evolved from his knowledge and understanding that he derived from men like Wilfrid LeDoux (the Twin-Line Chart); Chester W. Keltner (Keltner Channel); Richard Donchian (Donchian Channel); Geraldine Weiss (IQT); J.M. Hurst (Timing and Trading Cysles), and the like.

Technical

Bollinger calculated long-term deviation and used it to set percentage bands – in essence an adaptive version of percentage bands (source: Bollinger on BollingerBands by John Bollinger, McGraw-Hill, 2002). Most charting software calculates these bands – but for those of you who have an itch to calculate for yourselves, here’s the formula:

  1. Find the simple moving average: bollinger bands
  2. Having found the SMA, then calculate as follows: a) Forexb) FX

Charts

In the chart below, one of the first things that we notice about Bollinger Bands is that the price always moves from one extreme to the other. In other words, once price action has run its course at the lower band, it will eventually make its way to the upper band – and visa versa.

  • As we analyze a particular chart, we are initially looking for the bands to contract – showing low volatility; subsequently, we are looking for the bands to expand – demonstrating high volatility. We want to trade during times of higher volatility.
  • Constricted bands are like a person who is canoeing on a slow-moving stream – he has to work so much harder to reach his destination. However, put the same canoe in a fast moving river and a fraction of the effort is emitted – demonstrated by the expansion of the bands.
  • This is precisely what we are looking for in the Bollinger Bands – this is a “high probability” signal.

Breakouts

False Breakout

  • In looking for an entry opportunity, always watch for signs of a false breakout – I will guide you within the scope of each lesson regarding false breakouts but you will find, in each case, that experience will be your best teacher.
  • As the bands begin to widen, we are looking for a close above the upper band or below the lower band.
  • In the following chart, we have a close below the lower band (1) providing us with a signal for a potential short trade.
  • However, as the price began to retrace, it closed above the 20 SMA (2) signaling a potential reversal to the bullish side.
  • As the price began to fall again, we have three consecutive breaks of the lower band with NO subsequent closes of any kind below the lower band (3) – discounting a short trade. We now wait for the market to prove itself, again….patience.

technical analysis

A Conservative Trade

  • A close outside the upper band, candle (1), signals a potential long entry.
  • Since candle (1) has closed above the upper band, we immediately place a buy/stop order one pip above the high of candle (1) (if price is moving too fast to accommodate a buy/stop order, then jump in with two feet with a buy at the market).
  • As candle (2) begins to rise, it easily breaks the previous high by 13 pips – and we have entered the market with a long position at level (3).
  • Immediately upon entry of the market, our protective stop is placed a few pips below the 20 SMA (4) or (for an aggressive stop) below the low of the candles that broke the lower band after the bands began to widen (5).
  • Using the same principle, as the price continues in your favor, a trailing stop can safely be placed a few pips below the 20 SMA (6).

Forex System Trading

An additional Indicator with Trend lines as Confirmation

  • In this example, I have added the Relative Strength Indicator (RSI) with a setting of 21 and two sloping trend lines (1) and (2) to aide us in providing a higher probability trade and greater confirmation to the Bollinger Bands.
  • Now, some of you immediately may wonder why I am not using trend line (3) (the red dotted line) as my price trend line – and “cheers” to you for questioning. Remember, the false breakout previously mentioned – it was a failed entry, so we are past this point – so, moving along.
  • When using a trend line (1) within an indicator relative to a price trend line (2), remember to draw the lines in close relationship to each other. As you can see in this example, the RSI trend line (1) is directly below the price trend line (2) above.
  • Also, remember to compare apples with apples – when comparing two trend lines (one on a price chart and one within a separate indicator), make sure that the one trend line is drawn relative to the other – DO NOT draw a trend line on the peaks of a price chart in order to compare it to a trend line within an indicator drawn on the dips.

Now, let’s take a look at how to use this to signal a high probability entry.

  • Once trend line (1) and trend line (2) are broken (that’s “and” not “or”), we have a signal that a possible trade is developing – in this case, at points (4) and (5).
  • Now, if you look at the trend line break (4) on the RSI, you will see that it correlates with the trend line break (6) on the price chart (the red dotted line that we have discarded) which, as I said previously, we generally do not do; however, because the RSI pulled back at point (7) to trend line (1) without breaking below it, it is still a legitimate break to the bullish side.

Now, here comes the meat…..

  • Since RSI has not broken below the trend line at point (7), a close of candle (8) above the price trend line (2) provides us with the added confirmation we were waiting for.
  • Once candle (8) closed, a buy/stop order can immediately be entered one pip above the high of candle (9).
  • As candle (9) begins to rise, it easily surpasses the previous high of candle (8) by 71 pips – and we have entered the market with a long position at level (10). Pretty cool, huh?
  • Immediately, our protective stop would be placed below the low of the candle (8) or below the 20 SMA (11) – depending on how aggressive you are in your trading.
  • As the price continues in your favor, a trailing stop can safely be placed a few pips below the 20 SMA (12).

Bollinger_Bands

Adding to Your Position

Knowing that it is best to “let your profits run”, let’s look at the chart below to see how Bollinger Bands can aide in this strategy.

  • Now, let’s assume that you have already entered a long position at level (1) because of the candle (2) that closed above the trend line (described in the “meaty” section above).
  • Level (3) or level (4) would be the perfect place to add to your position. And here’s why…..
  • Because I said so, that’s why…..yes, mother dear. LOL.
  • Haha, here’s the real reason:
  • Let’s first look at entry level (3). Of all the candles in cluster area (5) that broke below the 20 SMA, only one closed below the 20 SMA – and insignificantly, at best.
  • In addition, each of the lows of the candles in area (6) was increasingly higher than the previous candle.
  • As added confirmation, the RSI reading (8) directly below the candles of area (6) was considerably above the 50-line.
  • A buy/stop order would easily have been entered one pip above the high of candle (7).
  • With candle (9) easily moving upward a fantastic 83 pips, we had no problem adding to our long position.
  • And since candle (9) closed outside the upper Bollinger Band (described above in the section “A Conservative Trade”), we had the perfect entry signal at level (4).
  • As price moves in your favor, protect your profits with trailing stops as described earlier.

Trading Signal

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Forex Trading Video
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Bollinger Band Reversal Signals

Now, this is where Bollinger really, really shines – and why it’s my most favorite indicator – so follow me closely here. During times of high volatility, price has a tendency to “walk” (and sometimes “run”) up/down the upper/lower bands. A close outside the band with a subsequent break and close inside the band can be a strong reversal signal – or a strong continuation signal. Now, before you walk away thinking, “This guy’s a bubble off plumb” – stay with me a bit longer.

Let’s look at cluster area (1)

  • We have a close with candle (3) outside the upper Bollinger Band providing a signal to enter long (as described earlier in this lesson).
  • So, if you’re not long already because of level (4), you will surely be in the market on the long side now, at level (5).
  • OK, here it is; candle (6), as expected, moves higher than the high of candle (3) – but something interesting happens here. Candle (6) closes inside the upper band – signaling a possible reversal (the operative word being – “POSSIBLE”).
  • Immediately – I move my trailing stop to a position that is a couple of pips above where I entered long (or may have added to my position) – red line (7), in order to protect my first and second entry.
  • However, the price fails to reverse, as expected (with no complaints), which would have been indicated by a drop below the 20 SMA – a victory for the bulls. And we remain in a long position.

Cluster area (2)

  • Once the price again closed outside the upper band within cluster area (2) with candles (8), I am adding (if I’m feeling real brave) to my position and my trailing stop is moved to position (9) – to the low of the second candle within cluster (8). Moving your stops at this point becomes a matter of equity and confidence – and is placed at the trader’s discretion. Don’t get GREEDY!!!
  • But low-and-behold, look what happens again; the candles (10) have moved higher than candles (8) but have closed inside the upper band – once again signaling a potential reversal.
  • However, knowing from experience, that often times a close outside the bands with a subsequent close inside the bands can be followed by a final “thrust” (11), I elect not to exit but I immediately move my trailing stop to protect my profits at level (12) – not too close, as to leave opportunity for the thrust upward. I then can decide to exit after the final thrusting action (11) or move my trailing stop to the 20 SMA. In either case, we are out of the market with a tremendous gain – and my Sweetie gets a night out on the town :o)
  • Now, this is trading. WOWSER!!

Moving Average

Please take note, at this point; I have used the word “possible” in describing the potential reversals. Why is that? It is because, until the price closes outside the opposite band, the reversal is not confirmed.

The price can continue to walk the band virtually indefinitely (or so it seems). And can even close across the 20 SMA and the trend can remain intact. Until the price crosses the opposite band, there is a higher probability that the trend is intact.

Also, the higher the time frame, the greater the credibility. For example, in this Daily chart below, the price walked the upper band for over 1000 pips and had an overall bullish move for over 1600 pips.

So, trader – beware. RSI divergence provided a great signal that this bullish trend possibly was completed – However, we will save that for the next lesson.

Charts

With surefire-trading.com, this is Ty Young, reminding you to “Read the Charts” – and have some fun doing it…….

Ty Young
surefire-trading.com

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