Rules of the method: None. This is
chart analysis, and every situation is different, so there are no
“enter when x crosses y” type rules here. You have to use your
brain... there is no blind rule following here! Indicators used:
None. All you need is the ability to draw lines on your chart.
Timeframe: Any timeframe will work, but
higher ones work best.
I don't trade on anything less than a 4
hour chart.
Pairs: This method works on any pair,
although I personally like GBP/JPY!
Candlesticks formations
I know candlestick formations and
patterns can be confusing, but don't worry. You don't need to
memorize dozens of candle patterns with weird Japanese names in order
to trade! All we need are two basic candle concepts... Long Wicked
Candles and Inside Candles.
Long Wicked Candles (LWC) are
just what they sound like, candles with long wicks. I've circled some
LWC's on the chart below. Notice that almost every time price changes
direction we see a LWC
“There are long
wicked candles all over that chart, and they aren't just in the
places where price is
reversing!”
You're right, but remember we aren't basing trades off these LWC's by
themselves. They are simply a tool to help us identify price
reversals. We need to use them along with all the other tools we're
going to learn later in the method.
The other type of
candlestick we're going to be using is the Inside Candle, also known
as an Inside Bar, or IB. Even though we're using candlesticks and not
bars I've gotten used to calling these IB's, so just humor me here.
An IB is a candle that is completely engulfed by the previous candle.
Notice how the top
of the green candle is lower than the top of the red candle, and the
bottom of the green candle is higher than the bottom of the red
candle? This is an IB. An IB is the same type of signal as a LWC. It
can tell us that a possible reversal is coming. Here's a chart with
some IB's circled.
Remember, we're
not taking any trades based off LWC's or IB's alone, they are used in
conjunction with the other lessons we're about to learn.
Support and Resistance Zones
Understanding
support and resistance is essential if you want to successfully
interpret Forex charts, but what exactly is support and resistance
(abbreviated S+R)?
What causes S+R is
an economic question that's beyond the scope of this lesson, but
understanding the reason for it really isn't important to us anyway.
All we need to know is this...
RESISTANCE
levels exists above the current price, and act as a barrier to the
price increasing above the level. Imagine you were inside your house
and tried to jump up through the roof... You would encounter
resistance from your ceiling, and it would be very hard to break
through that resistance.
SUPPORT
levels exist below the current price, and act as a barrier to the
price falling below the level. When you fall back down from your
previous jump you will encounter support from the floor when you hit
it. You would have to do a lot of stomping to break through the
support of your floor So why is it important that you know where the
current support and resistance levels are? The reason is simple...
Support and resistance levels are places where price direction can
possibly reverse onyou. So if you know ahead of time where they are,
then you can take profit on your trades before the price reverses
against you, and you can enter into new trades!
So how do we find
these S+R levels. It's actually pretty easy, it just takes practice
to get good at it.
Look at this
chart... The gray bar marks a very strong area of support. A total of
15 candles have their bottoms on or in this gray box. I call an area
such as this an S+R zone.
Here's the same
chart, with an area of resistance added. A total of 9 candles have
their tops on or in this gray box.
We can see in the
above picture that the price is heading back up, so if we were in a
trade where do you think a good exit point might be? That's right,
the upper S+R zone!
You may have
noticed that I'm using what I call S+R zones, and not single S+R
lines like a lot of other traders. Lines tend to be too rigid for me,
because prices rarely bounce directly off a certain line. A zone is a
much more realistic representation of S+R levels. So how do we use
these S+R zones to trade? You can trade directly off S+R bounces, but
I like to add one more tool to the toolbox... The trendline!
Predicting Trends
Anyone who's been
trading for any time at all has heard the phrase “The trend is your
friend,” but what exactly is a trend, and more importantly, how to
we predict them and use them to our advantage?
A trend is nothing
more than a series of higher highs and higher lows (or lower
highs/lows for a downward trend). The following picture is a GBP/JPY
daily chart. I've marked the trend with two purple trendlines, and
I've circled the significant high/low points of the trend. Notice how
the high points I've circled in blue keep getting lower and lower,
and how the low points circled in red also keep getting lower?
When this pattern
of lower highs and lower lows stops it means the trend is coming to
an end, and that a new trend will be beginning. Here are the three
things to look for that signal the death of a trend.
1. A break in the
trend's trendline. A trendline is just a line connecting the
significant high/low points of a trend.
2. A high that's
above the previous major high point.
3. A low that's
above the previous major low point.
This example is
for a downward trend, an upward trend would need to use the opposite
of steps 2 and 3. On the next page is a chart that zooms in on the
end of this trend and shows these 3 things.
All 3 criteria
have been identified, so we can safely say this trend is coming to an
end and a new trend is beginning.
Here's a chart
that shows our signals were correct. The old downward trend ended and
new upward trend began. It did not last very long, however, and you
can see the same 3 signs again at the point where the new trend
ended.
See if you can
pick them out...
Finding Entries, Stoplosses and
Profit Targets.
Let's practice
putting everything we've learned together to find potential trades.
Here is a EUR/JPY 4H chart with trendlines and S+R zones already
drawn. Can you see the trade opportunity?
As you can see,
the last candle on the chart is a Long Wicked Candle, and it has
bounced directly off both an S+R zone and off a trendline. This makes
it an excellent trade opportunity! But when do we enter, and what do
we use for our stoploss and profit target? In the picture on the next
page I've added two lines to our chart. An orange line for our entry
point, and a red line for our stoploss.
The Entry:
Before we enter we
need to confirm that this is a valid price reversal. Even though all
the signs of a reversal are there, we need to be safe and wait for
the actual reversal to start. To confirm the price is reversing we
want to wait until the current candle moves a few pips above the red
LWC that signaled the reversal. This is represented by the orange
132.45 line in the above picture. After the price broke above that
orange line I would have entered the trade. Remember, we're not
waiting for the candle to close, just move above the line. If we wait
for a close we'll miss out on too much profit!
The StopLoss:
We want our stop
to be somewhere safe, in a place is is very unlikely to get hit. In
this case I would place my stop at the red 131.40 line, which is on
the other side of both the S+R zone and the trendline. You'll also
notice that if price did reach this level then we would have a lower
low than the previous 131.46 low. This would mean our upwards trend
was failing, and that the price is probably not going to go back up
anyway, so it's a great place for a stoploss.
The TakeProfit:
For a TP level I
would be watching two different areas, the upper S+R zone, and the
area around the upper trendline. If the price started to reversal
around the S+R zone, I would take my profit and be out of the trade,
but if it moved through the zone, I would exit around the upper
trendline. You could also exit half your position at the S+R zone and
the other half at the trendline, if you prefer. Either way is
acceptable. Let's look at the chart after the trade is completed...
As you can see,
the candle after our entry flew straight through the S+R zone, and on
the candle after that price touched our trendline, signaling our exit
from the trade. If you got out on the trendline touch you would have
gotten 230 pips with a 105 pip risk. That's a reward:risk ratio of
2.19, and was an excellent trade. Even if you waited and got out
after the bounce you still would have gotten +180 pips That's the
conclusion of my basic chart analysis method, but here is one more
picture to help you see how to spot trades. In the following picture
the orange line is the entry, the red line the stoploss, and the dark
green is the profit target.
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