jump to navigation

The dollar finally rallies and I miss it! August 7, 2008

Posted by theforexwriter in general trading.
add a comment

I’ve been off-line and out of touch for over a week now with computer problems (a virus which deleted some stupid little files that I couldn’t track down followed by my computer refusing to talk with the Internet) and I have done no trading since posting the results listed below. Yes, I missed all the initial dollar rally and all the excitement. But now my computer is fixed and I’m ba-a-ack! I’ll resume trading and post new results as they happen.

Advertisements

First week’s report and commentary July 21, 2008

Posted by theforexwriter in general trading, moving averages.
Tags: , , , , ,
add a comment

I have become enamored of the accelerator oscillator. Although I’ve had little experience with it prior to this experiment, I’m finding that it has much to offer, warning me when the current microtrend is softening and preparing to pull back. For day trading, this allows me to enter the market as the microtrend reverses, ride it to its end, and then exit when it again pulls back. It’s not foolproof—at least not against this fool—but I’ve placed two trades using the system this week, both positive, for a total of around 50 pips.

Not a lot, no. I’ve been busy elsewhere and haven’t had a lot of time to put into forex trading this week. (Check out PickensPlan.com if you’re curious as to what has distracted me.) And I definitely missed some awesome trades that were clearly signaled, such as the illustration below. Note how the combination of the moving average crossovers, Dean Malone’s Trader’s Dynamic Index in the bottom indicator window, and the accelerator oscillator in the middle one all confirm each other going into that long upslope. Even this fool couldn’t have missed that one!

Note that what the accelerator oscillator measures is not the direction of the trend, nor even its strength, but its momentum. When the trend is moving hard and fast, the histogram bars become long, but when the price action is channeling without a lot of direction, they become short. This helps the forex trader to gauge whether a change in trend is an actual reversal (long bars, more than three or four of them grouped together) or just a pullback for profit taking (shorter bars and not as many of them).

Remember:

  1. Have a strategy.
  2. Plan your trade.
  3. Trade your plan.
  4. There’s no such thing as always.

More later. Happy trades to you.

Testing a new strategy July 13, 2008

Posted by theforexwriter in moving averages.
Tags: , , , , , , , ,
6 comments

After being whipsawed for much of the previous week, I’ve started testing a new technical forex trading strategy, similar to the one discussed in “Time Passages,” below. You’re welcome to follow along or paper-trade it for yourself if you have a mind.

Because risk aversion and market jitters are shrinking trading ranges and reversing price action with little warning, I’m trying this as a day-trading strategy on thirty-minute charts, to grab a few pips from a chronically choppy market. Because this is a trial session, I’m concentrating on only one currency pair, the AUD/JPY, selected because it’s very sensitive to fundamental market shocks. (The carry traders panic and exit fast if some announcement scares them, and I expect that to continue at least until the Freddie and Fannie crisis abates. Of course, there’s likely to be another crisis after that one, but hey, that’s life.)

The proposed system consists of two exponential moving averages (EMAs) of shorter duration than I normally use, both calculated on closing prices, plus the accelerator oscillator used in a non-traditional way. I also actively mark support and resistance levels and track volume.

The moving averages are:

1. a three-period EMA (the blue line);

2. a twelve-period EMA (the brown line); and

3. a 200-period simple moving average (SMA) also calculated on the close (the grey line).

The accelerator oscillator is designed to measure changes in the momentum of a currency pair’s price action. Results are displayed as a histogram, similar to the MACD, in an indicator window below the chart, with green bars indicating acceleration and red bars indicating braking. Traditional use is to buy on two consecutive green bars above the zero line or three consecutive green bars below the zero line, and to sell on two consecutive red bars below the zero line or three consecutive red bars above the zero line. This is an involved way of saying, go with the trend. (We’ve all heard that before, right?)

For this plan, though, what I’m going to concentrate on is the height of the bar. Unless the acceleration or braking pressure is great enough to convince me the market means business, I’m not gonna play. So using the MetaTrader 4.0 platform, I changed the indicator settings so that the accelerator oscillator displays a little grid behind the histogram, at 0.05 intervals, both above and below the zero line. (Use the hyphen as a minus sign, MT4 understands.) Unless the histogram bar touches the grid, it’s not an entry alert.

With moving average crossovers, of course, you buy when the shorter period crosses above the longer one (in this case, when the blue line crosses above the brown) and sell when it crosses back. I like to see a lot of daylight between the lines when they cross—a little niggling cross where they almost parallel each other just doesn’t count.

The SMA(200) indicates the long-term trend. I find it easier to track if it’s an ever-present graphic.

A long entry alert will be the blue EMA(3) crossing above the brown EMA(12) with a good, clean cross. The actual signal will be when a green histogram bar touches the first grid line above the zero.

A short entry alert will be the blue EMA(3) crossing below the brown EMA(12), also with room between them. The actual signal will be when a red histogram bar touches the first grid line below the zero.

The exit strategy is still a little hazy. In this choppy market, an exit will probably take place whenever my gut dictates. When this becomes clearer, I’ll let you know.

Take a look at some of my back-testing:

There are three trades on this chart that meet the criteria, with entry points marked by light blue vertical lines. All three would have been profitable.

I’ve gone back farther than that with the back-testing, of course, but I prefer to test new systems live on my paper-trading account. So I’ll try this one when the market opens tomorrow.

One thing this choppy market is teaching me is to be flexible. Have a strategy, yes—but be willing to try new ones, too.

Surviving in a volatile market July 1, 2008

Posted by theforexwriter in general trading, moving averages.
Tags: , , , , , , , , , , , ,
3 comments

In the last two weeks, my mini account got hit hard. I executed several poorly-timed trades, twice entering the market just as it turned south and moved against me without warning, for losses of just over 10% of my account.

In one of those trades, I went long the AUD/JPY just as a fresh round of risk aversion slammed the market, but I assumed it was just some big traders taking profit off the table, moved my stop down to a level that I figured would never get hit, and went to bed. In the morning, my equity and my jaw both dropped.

Don’t get me wrong. I can deal with the market moving against me; it happens to everyone whether they admit it or not. The trick, though, is to minimize the losses and maximize the gains through good money management, not to ASS*U*ME that a certain level of support will make a good stop-loss level and then turn out the light. I mean, I should have just donated the money to my favorite charity and saved myself a lousy morning.

So here, for all to see and gloat over, are some rules of survival in a volatile and choppy market.

Keep the fundamental announcement calendar right by the keyboard. Economics are kinda chancy these days, with many reserve banks stuck between rising inflation and falling growth. They can’t raise interest rates without risking weaker growth and they can’t lower rates without risking stronger inflation, and everybody knows it. So traders are watching fundamentals closely, hoping to confirm or refute expectations of future interest rate and therefore market movements.

When an announcement is pending, think about exiting trades associated with that currency, unless of course you’re absolutely certain what it’s going to say, and even then, consider getting out. Economic indicators have been surprising both experts and amateurs lately, and the market has been moving radically in response. As an example, when the FOMC released their interest rate decision last week, the market at first interpreted the accompanying statement as hawkish and the dollar started rising, only to fall off a cliff a few minutes later. A lot of amateur traders got slammed.

When the ECB moves this Thursday, it’s likely to happen again, so hang onto your hard hat and your money. Consider waiting until the direction of the market’s move has been confirmed before joining it.

Don’t trust the market. A choppy and volatile market is no place to ignore basic good trading skills. Take the time to mark support and resistance levels; look for channels, Fibonacci retracements, and chart patterns; calculate ADR levels; and look for levels where more than one of these technical indicators coincide. That’s where the bulls and bears are likely to make their stands, where the market is likely to turn, and likely spots for an entry or exit. Look for confirmation (as I should have done) before committing to the trade, and use good money management techniques, never risking more than your established maximum amount per trade.

Check the chop before you dive in. A trick I learned from Dean Malone of CompassFX is the five-period moving average channel, with one SMA calculated on the high price and the other on the low (an example is visible on the USD/CAD chart below). Check the price action on the four-hour chart before trading. If it shows a series of dojis, spinning tops, and random bull and bear candles clustering within the channel, then the market is choppy and it will be even harder to grab a few pips than normal.

Trade pullbacks, as the 5EMAs trading system teaches. Movements aren’t likely to be sustained for long, as many currency pairs, particularly USD crosses, are pulling inside rather narrow ranges like tortoises inside their shells. When an honest profit has been made, consider taking it off the table. The alternative is to see a good trade head south, taking your profit with it.

Trade channels and place hedges above and below for breakouts. As the daily chart of USD/CAD below graphically illustrates, range-trading is in right now. Since late November of last year, USD/CAD has moved within three cents, plus or minus, of parity (marked by the central red horizontal line) and although a number of pundits are predicting it will rise out of that range later this year, well, it hasn’t yet.

There’s a lot of inherent risk in the forex trading market, and I generally expect one-third to one-half of my trades to go against me. More than ever, in a volatile market the rules should apply:

1. Have a strategy.

2. Plan your trade.

3. Trade your plan.

4. There’s no such thing as always.

Happy trades to you.

Scams make my blood boil June 25, 2008

Posted by theforexwriter in general trading.
Tags: , , , , , , ,
1 comment so far

I’ve spent some time recently looking at forex trading schemes, those “systems” that are advertised online where you spend some outrageous amount of money for a set of DVDs, CDs, books, software, whatever. I’m not going to name names here (my one well-meant attempt at whistleblowing proved disastrous), but what I’ve seen infuriated me. Let’s go through some of these claims.

“Make insane profits!” Yes, it’s possible to make large amounts of profit through forex trading. But it’s not easy. Statistics show that more than 90% of novice forex traders lose all of their investment account within three to six months. These people generally decide the forex market is not for them, and they leave never to return. Of those remaining, about half (5% of the original number) do fairly well, 4% earn a decent living, and only 1% make it really big.

“It’s fully automated!” Forex trading is an art, not a science, and has more in common with a jury deciding a court case than a database analyst crunching numbers. The most successful forex traders examine all of the information available—technical indicators, fundamental announcements, experts’ forecasts, market expectations, and so on—and enter the market based upon their judgment of where the preponderance of the evidence seems to be pointing. Systems that look only at a set of technical indicators and enter a trade whenever its preferred set of variables has been met is no more scientific than a monkey flipping a coin. As an example, such a system would have been creamed today on EUR/USD and USD/CHF following the FOMC announcement.

“Over 90% winning trades!” Yes, it’s possible for a trader to call it right over 90% of the time—after some intensive study, enough paper-trading to feel comfortable with his or her system, and acquiring some knowledge as to what moves the market. None of that is going to happen overnight and claims of achieving success with ten minutes a day are preposterous.

Testimonials at any time are extremely suspect and online ones are the most questionable. I write freelance, and I’ve seen help-wanted ads looking for writers to compose testimonials—for pay. As my husband pointed out in the midst of my ranting, anyone can rent an expensive car, drive to a showy part of town, park the sucker, and take a photo. It means nothing. For the salesman, it’s an investment and can be written off on his or her taxes.

Yesterday I saw an example of the “live trades” profits earned by one forex trading system. While looking at this supposedly unbroken string of winning trades, I realized from the layout of the data that this system was based upon an excellent trading platform called MetaTrader 4; the layout was unmistakable, in particular the pink and green highlighting applied to some of the trades. Therein lay the problem—with MetaTrader, pink highlighting means a losing trade!

My blood boiled as I realized that some clever graphic artist had removed the negative signs from in front of those pink-highlighted figures and altered the total profit at the bottom of the column, to disguise the fact that half of those trades had lost money rather than earned it. This is lying, and no matter what potential that firm’s trading system otherwise holds, that one action moves their product to the scam category.

I personally use MetaTrader through the brokerage CompassFX. As I stated earlier, it’s an excellent charting service and trading platform, versatile, easy to use, and best of all, free for the downloading. It will not tell you when to place a trade (or not), and I believe it has no connection with the aforementioned scam other than being the software used to concoct it. That’s like using Open Office or Word Perfect to compose a fraudulent sales letter; it doesn’t harm the software used, only the reputation of the scam artist perpetuating the deceit.

Think of learning forex trading in the same way you’d consider learning any other career field. You wouldn’t expect to become a high-priced surgeon without undertaking some study, would you? Anyone who tells you that a) you don’t have to work hard, b) you don’t have to study, c) you can do it in minutes a day, d) you’ll never lose, well, they’re lying to you. Don’t give them your money; you worked too hard to get it to throw it away on such liars.

If you’re not serious about putting hard time and effort into forex trading, again, save your money. Don’t even open an account. You’ll be one of those 90% who are out on the street, violating the decency ordinances by strolling around without a shirt.

If you’re serious about learning forex and are willing to study and work, with the long-term goal of either supplementing your income or replacing your day job, here are a few suggestions.

Sign up for Dean Malone’s Synergy method. His basic program is free, it has a ton of potential, and he supplements his course materials with free videos where he discusses the ins and outs of the forex trading market.

This is the 5EMAs trading system. It’s not free and it’s not as easy as the sales materials claim, but it’s a balanced system and it’s honest. Note that, when you click on the link to see someone’s live trading balance sheet, it shows some negative figures along with the positive ones. That’s reality.

Remember:

  • Have a strategy.
  • Plan your trade.
  • Trade your plan.
  • There’s no such thing as always.

Happy and safe trades to you.

Currencies are people, too June 21, 2008

Posted by theforexwriter in general trading.
Tags: , , , , , , , , , , , , , , , , , ,
4 comments

Let’s talk about some of the major currencies (USD, EUR, GBP, CHF, JPY, CAD, AUD). These comprise the currency pairs with the most action and the lowest spreads, and more brokers handle them. Many minor currencies have good features—the Mexican peso moves in long sharp trends that are a trader’s dream, more than recouping that enormous spread, and the BRIC nations of Brazil-Russia-India-China are all rocking—but we’ll get to them in some future entry.

I can’t emphasize enough that each individual currency pair has its own unique motion and characteristic “behavior patterns” that influence the way it should be traded. Experiment with several currency pairs to find one or two that suit your trading style, then get to know those pairs intimately through observation and paper trading prior to investing your money in the live forex market. It may take six months or more, but it’s worth it because of the money you save through not being “head-faked” by the market, as noted trader Dean Malone of CompassFX phrases it. Take the time now and learn all you can, find the currency pair that works for you, and practice before you trade. You’ll be glad you did.

Major players

According to data gathered by the Bank for International Settlements, USD, EUR, and GBP account for roughly two-thirds of the average daily volume in the forex trading market, and the U.S. dollar alone is involved in more than a third of all trades. That’s a tremendous amount of liquidity, and it gives EUR/USD in particular a deliberate, tick-tick-tick motion that seems ponderous in comparison to some of the more lightly-traded currency pairs. This liquidity also keeps slippage to a minimum, making EUR/USD great for scalpers and day traders who don’t want to lose a single pip, and it can take a long time to break through support and resistance levels with so many stop-losses and take-profits floating around “out there.”

All emotions, patriotic sentiments, and political leanings aside, the U.S. dollar remains the benchmark for the world’s currencies and U.S. economic data remains the major driving force in fundamental announcements. Yes, currency pairs react to announcements from other nations but to a lesser degree, and by sheer volume, forces related to USD movements continue to lead the market.

The Euro is a sort of “anti-dollar,” much like matter and anti-matter in the Star Trek universe, and even here U.S. announcements push the currency pair around more than those from the Eurozone. Check related currency pairs, such as GBP/USD or USD/CHF, and EUR/GBP or EUR/CHF, to see which side of the equation is forcing a movement (and for possible correlation trades).

The pound sterling is not quite as liquid as USD or EUR, so its movements are sharper and it doesn’t pull back as often on profit-taking. If you’re caught on the wrong side of a pound-cross trade, it’s generally best to just get out rather than wait for it to turn around or pull back, but if you’re on the right side of the trade, use a trailing stop to lock in profits. False breaks and false signals are also common here.

Because U.S. data tends to move the European currencies, traders who specialize in EUR/USD tend to watch GBP/USD or USD/CHF even if they don’t trade those currency pairs. These two often react in the same manner to the same announcements, but with their lower liquidity levels, they move more quickly, and if they breach a support or resistance level, chances are good EUR/USD will follow suit shortly.

The safe-havens

I should perhaps mention that JPY can also be considered one of the majors, as it’s on one side or the other of 16.5% of all forex trades, but because it tends to trade more in line with CHF than any of the currencies discussed above, I decided to put it here instead.

Because Switzerland and Japan are conservative countries with solid fundamentals and the lowest interest rates in the industrialized world, their currencies are considered to be more stable than most. When times and financial returns are good, investors tend to ignore them and dabble in riskier investments, but when economic and political crises slam the forex and stock markets, these same investors tend to run for shelter. Sometimes they head for commodities such as gold or crude oil, but often they run for the Swissie and the yen in the belief that, even if the rest of the world falls flat, these two bastions will remain strong.

For this reason, CHF and JPY don’t always trade in response to their nations’ fundamentals. JPY tends to reflect the amount of risk appetite or aversion amongst traders (see the discussion of AUD/JPY, below), while CHF, like the Euro, seems to be something of an “anti-dollar” and reflects how bullish or bearish traders feel toward the U.S. economy. Only a shift in interbank interest rates (very rare with these countries) or a sharp rise in unemployment or inflation seems able to spark a movement in CHF and JPY that is unrelated to these trends.

The commodities-related currencies

These nations depend heavily upon exports of raw materials and manufactured goods for economic growth, so when the prices of commodities are high (like now), their economies are generally booming. It’s best to be specific when using this trading technique. For example, Canada contains the greatest oil reserves in the world outside of the Middle East, so when the price of West Texas Intermediate pushes higher, watch for CAD to follow, especially if gold or building materials are also strengthening.

Around 80% of Canada’s exports head due south to the U.S., so when the U.S. economy is hurting it tends to drag that of Canada down with it. Right now crude oil is high but the housing market is soft, so building materials among other factors, such as slowing industrial growth and lowering interest rates, are beginning to weigh on CAD.

Commodities that comprise large chunks of Canada’s exports include crude oil, natural gas, foodstuffs, forestry products such as lumber and paper pulp, and metals and minerals such as gold, platinum, copper, zinc, and potash.

Australia exports iron ore, coal, gold, crude oil, wheat and other grains, and LNG. Because of Australia’s position in the Pacific, many of their exports head to Asia, Africa, or South America rather than North America or Europe, so their economy is less influenced by downturns in the developed world.

Currently the Australian economy is at the peak of an incredible expansion boom—perhaps just past the peak—and they’ve been growing so fast they’re superheating, with inflation 4.2% higher than this time last year and an interbank interest rate of 7.25%. However, there are signs that the government’s attempts to slow their explosive growth to something sustainable are finally taking hold, with retail sales and demand for housing loans falling off from multi-year highs.

Of special note is the currency pair AUD/JPY, which is a favorite of investors who stash their funds in what’s called the carry trade. In this strategy, an investor borrows money in a country with a low interest rate, such as Japan (0.50%—yes, that’s right, the Japanese interest rate is half a percentage point), then invest that money in another country with a high interest rate, such as Australia at 7.25% or New Zealand at 8.25%, although that one might soon be falling.

The investor’s funds earn the difference between the interest rates, but there’s the possibility that a change in the forex market could wipe out their earnings and even some of their capital, which happened in late July of 2007 when the currency pair lost over 2000 pips in four weeks, as shown below. Those huge heikin ashi candles to the right of the chart represent the start of the subprime mortgage fiasco, when investors out a carry-trade limb lost money by the decimal place.

Anyways, AUD/JPY serves as a barometer of investors’ risk appetite or aversion. When the big money feels comfortable putting their funds into something risky and potentially rewarding, they head for the carry trade and this currency pair goes up as they buy AUD and sell JPY. On the other hand, when financial markets implode and investors scramble for the shelter of safe-haven currencies, AUD/JPY turns down as they remove their funds from the carry trade and look for somewhere safer to stash it.

This see-saw pattern makes for a volatile currency pair with some huge and rewarding moves within fairly well-defined ranges, and it’s usually obedient to repeating support and resistance levels. Because this pair is open during Asian and Australian banking hours, roughly between 2:00 PM and 11:00 PM in the U.S., it’s a good one for evening U.S. traders who aren’t yet ready to leave their day jobs.

Happy trades to you.

Time passages: crossovers in the market June 14, 2008

Posted by theforexwriter in moving averages.
Tags: , , , , , ,
2 comments

The concept of a simple moving average (SMA) is, well, simple: the more time periods used to calculate it, the less sensitive the results; the fewer used, the more sensitive.

An SMA calculated over one time period, to use a silly example, is the same as the price used to calculate it, and therefore the line graphed of such an MA(1) by your charting software atop your forex trading chart would follow in lockstep with that price.

One calculated over two time periods, an MA(2), would average those two prices and trace a line between them on the chart.

As the number of time periods used in the calculation continues to rise—three, four, ten, 100—the averaging process means that any single price has less effect on the SMA as a whole, thus lessening its overall sensitivity to sudden changes in trend. If a currency pair makes an abrupt dive or climb, it takes a while for a long-term SMA to catch up, which is why it’s categorized as a lagging indicator: it shows where the price has been.

An SMA calculated over a very large dataset—say, 200 time periods—has lost almost all of its sensitivity to sudden market fluctuations. Its most common use is as a long-term trend indicator, e.g., when the current price is above its MA(200) graph, it’s above the average of the previous 200 prices and therefore the trend is rising; if the current price is below the MA(200), the opposite is true.

On the other hand, an SMA calculated over a fairly small dataset—five time periods, for example—responds pretty quickly to changes in the market’s direction. Sometimes, though, it responds too quickly, not smoothing out enough of the market’s jitters and “background noise,” and giving technical traders false entry and exit signals, ruining what otherwise might have been a perfectly good day.

So if a small dataset creates an SMA that’s too sensitive, and a large dataset makes one that’s not sensitive enough, what’s a technical trader to do? Barbara Rockefeller, in her primer Technical Analysis for Dummies (2004, Wiley Publishing, Inc.), gives a good answer to that question. It’s called the moving average crossover.

Here’s the strategy:

Plot two moving averages atop your currency pair’s chart, one with a small dataset and one not quite so small. I personally like using an SMA(5) and an SMA(20), and for the rest of this blog entry I’ll use those two as my working example, but each trader should experiment to find the exact indicators that work for his or her favorite currency pair. (Remember that each currency pair has its own unique characteristics, and what works fabulously for one might fall flat on its face with another.)

When the SMA(5) crosses above the SMA(20), that’s a signal to enter the market long, and when it crosses below, that’s a short-selling signal. (Another thing to remember is that each trade should be based, not on one market signal, but on several. This strategy works better and generates fewer false entry and exit signals when combined with an oscillator such as the RSI or MACD, and we’ll cover those in future posts. But there’s no strategy on the planet that never generates a false signal, because in forex trading, there’s no such thing as always.)

Check out this chart:

This is the current one-hour chart of the U.S. dollar vs. the Mexican peso (USD/MXN), with the SMA(5) plotted in yellow and the SMA(20) in light blue. It’s obvious that this currency pair has strong trends and a lot of volatility (it moved almost 900 pips on June 10, lost almost half of that June 11 then regained it and more during the afternoon, and then lost almost all of its gains on June 12, man, what a ride) so it can be a good currency pair for this strategy. But again I emphasize, use additional indicators to confirm any signal before you enter the market. It’s also worth noting that, as a minor currency pair, this one generally has a reeealllly wide spread and a lot of pips to earn before you get a penny.

Anyways, when the yellow line crosses above the light blue line, that’s a buy signal, and the more “air” you can see between the two lines, the stronger the signal is. On June 10, when the market moved so dramatically, there’s enough room between the two SMAs to drive a Mack truck, and signals just don’t get any stronger than that.

This is one potential moving average strategy. It’s not patented by any means, so feel free to paper-trade with it and customize it to your own trading needs, experimenting with combinations of time periods and other technical indicators to find the fit that’s perfect for you and your favorite currency pair.

And happy trades to you.

Moving averages: a powerful weapon in the forex trader’s arsenal June 13, 2008

Posted by theforexwriter in moving averages.
Tags: , , , , ,
2 comments

It’s estimated that more than 80% of all retail forex traders lose their shirts in the marketplace. For that reason, those novices new to this arena are wise to study, not only the wiles of individual currency pairs to learn their characteristics, but also the various technical indicators that can clue them in to range breakouts and potential profits.

One of the more powerful of these technical weapons, as I like to call them, is the moving average in all of its various forms.

A moving average is just what it sounds like. It’s the average of a chosen number of prices from a single currency pair within the forex market, with the average “moving” as the oldest price is replaced by a new one whenever the time period advances. A moving average can be calculated on any price—open or close, high or low—and over any number of time periods from three to three hundred. Once calculated, the moving average is graphed atop the chart of the currency pair under discussion, where it demonstrates whether that pair is responding to greater buying or selling pressure than during those preceding time periods.

There are many types of moving averages. The ones I personally use most often include:

  • the simple moving average (SMA), which is calculated the way we learned in school, i.e., adding the prices together then dividing by the number of time periods, thus giving equal weight to all of the prices; and
  • the exponential moving average (EMA), which gives more weight to recent prices over older ones in order to reduce the lag time, so the indicator reacts faster to changes in the price action’s direction.

See this chart?

This is a one-hour chart of the Australian dollar versus the New Zealand dollar (AUD/NZD), and it’s been remarkably volatile lately, giving forex traders many opportunities to take pips off the table. The green horizontal lines pinpoint long-term support and resistance levels, and what I want you to notice in particular is how the red and white average price bars bounce around between them for a while, then break out and either climb or drop rapidly. (This often happens when the volume, the green vertical lines at the bottom of the chart, is at a high level, but not always. The fourth rule in profitable forex trading is, there is no such thing as always.)

Now check out the two purple lines that seem to surround those price bars. Those are five-period SMAs, one calculated on the opening price and the other on the close. When a currency pair’s momentum is particularly strong, as it was during those times the pair broke out from between the green lines, those price bars will actually poke through the walls of that SMA channel. When the solid part of the bar pushes its way out, you know that’s a potentially profitable trade.

Here’s another chart:

This is the same chart, except the five-period SMA lines have been replaced with two ten-period EMAs, one calculated on the opening price (purple) and the other on the close (blue). Note that, when these two lines cross, it’s often (not always) at the start of a run, which doesn’t quit until the two lines cross again, an example of one potential EMA trading strategy suitable for these breakout runs.

The moving average is a powerful technical weapon and it’s one I intend to discuss often, but it requires a fair amount of experimentation and paper trading to determine the best combination of time periods for each currency pair. If you’re willing and able to put in that study time, great and what are you waiting for, but for those of you who don’t, here’s a link to a trading system that has a ton of potential.

And remember theforexwriter’s rules for trading:

  1. Have a strategy.
  2. Plan your trade.
  3. Trade your plan.
  4. There’s no such thing as always.

Happy trades to you.