Chapter 5: Professional Speculation and Technical Analysis

The Concept of Trading

• Professional Forex Trading is the art of using short term price movements in interbank Foreign exchange to make profit.

• Using Price Charts, our focus is to trade with an “EDGE” to successfully trade price movement from point x to point y.

• We must predict price direction correctly, execute a trade entry, and then manage the position between our predetermined stop loss level and desired take profit level.

• Our winning edge is found using Technical Analysis, specifically, price action analysis.

• I.E. Finding Price action signals, Working with short term market trends and identifying key support / resistance. These tools are combined to create our winning edge.

• Traders should use entry methods which have a robust edge, even if the winning edge is small, we favor entering a trade using a repeatable and tested method as opposed to randomly chasing prices.

• A robust edge is a proven market event, it is a repetitive price event in the market which acts as a “signal” create an order in the market.

• Risk Reward is Crucial

• Traders often fail in the forex market when they trade with emotion, riding the highs and lows, similar to that of a black jack player in a casino.

• They can’t follow rules, set goals and certainly have no consistent trading method. We must do the opposite to the masses of traders in order to win.

• Risk reward is the most important aspect of trading. It is the mathematical equation which tells us how much we stand to risk and how much we stand to lose on any single trade.

• If I was to risk 50 cents to make $2, my risk vs. reward would be 4! Also written as 1:4

• As traders, we can control our risk reward on every trade. A high reward for our risk is an obvious goal of every trader.

• Every trade setup carries a unique degree of risk versus reward. The cliché – “make your winners larger than your losses” is the most obvious road to wealth in trading

• Often, traders lose focus, and they forget what each trade can realistically offer them in terms of profit. Markets do not move in straight lines, yet traders hold on to winners way too long expecting some giant winner, and soon… They see these profits evaporate.

• You must lose all greedy emotions and stick to your rules! Most basic trading setups aim to deliver approx. 2 to 3 or 4 times what you risk, and we should be happy to take that kind of profit. This equation means we can win 1 in every 2, 3 or even 4 trades and still make decent profits over a large sample of trades.

• When Forex trading, we are effectively running a company. Trading Losses are the cost of business, wins are our revenue.

• The number one winning attribute of all traders is patience.

• Wait for your desired trading setup, don’t ever enter just to be in a trade. Great traders often speak of being “neutral” or not in a position, as the most profitable trade setup there is.

• Once a perfect setup is identified, a winning trader will act on it with discipline.

• Trade the setup you see, believe what the market is telling you.

• Never panic or become anxious in the face of missed trading opportunities. Remember the market will be open again tomorrow, and never fall into the trap of getting on every single move.

• Try to be a short-term trend follower as often as possible, don’t be the hero who picks every top and bottom. Of course, there will be exceptions, but when starting, try to be a trend follower.

• If you miss a setup, don’t chase prices, most of the time there will be a second opportunity to re-enter.

• A good trader will only take trades that meet strict criteria in his or her trading plan.

• Technical analysis or “T.A.” is the study of historical price action represented on a chart. It is the examination of past price movements to anticipate future price movements.

• This method of market analysis is used to study short term and long term price graphs. We can apply technical analysis to all financial markets.

• As Forex traders, we are 95% focused on technical analysis to generate trading signals.

• Let’s use the price of fuel as an example. We want to graph the price of petrol price over a 3 week period.

• Time is plotted on the bottom price axis and the day to day price is plotted on the right hand side axis.

• We can see clearly that the chart shows Wednesday is the cheapest day to buy fuel.

• We might assume, Wednesday is therefore the best time to buy, or Wednesday is ‘support’…

• Price action is the single most important thing traders need concern themselves with on a day to day basis. It is the all-encompassing key to all aspects of profitable trading.

• Price action takes into account every aspect of what is happening in the market and around the world at any precise moment.

• Price action will define where the key market levels are, and will provide price patterns and signals to trade from.

• A naked, raw candlestick chart like the one shown below, should be the most used tool in every trader’s toolbox…

• A support level is the level of price which buyers are expected to enter the market in sufficient numbers to take control from the sellers.

• A Resistance level is the level of price which sellers are expected to enter the market in sufficient numbers to take control from the buyers

• These horizontal levels are important because they provide clues to where the market MAY react in the future.

• Price can either break through or hold a horizontal chart level.

• I rarely use support and resistance to enter a trade unless I have price action confirmation at or near the level. If there is a strong trend and I am selling a retracement, I may use support and resistance for a low risk entry.

• Once broken, swing points act as containment (support or resistance) in the direction of the trend. That means basically that where there was old supply, there will be new demand, and where there was old demand, there will be new supply. This is an ever-changing trait of markets, and basically drives all trends.

• Static support and resistance on longer term price horizon is more relevant to trade from. So when doing study, look at time frames above 240 minute chart for intraday traders, with daily and weekly being ideal for end of day traders.

• Support and Resistance rotate over and over, meaning, old support becomes new resistance, and old resistance becomes new support. The smaller the time frame the less accurate and more often it changes.

• We don’t always trade from support and resistance, we may use the level to place a stop loss. E.g., if we enter a trend trade to the long side (bought) at a moving average, we might place our stop under support. (The opposite is also true, a short trade might mean we place our stop loss above resistance).

• Support and resistance work best in trending markets and can be seen working on both short and long term time horizon…

• There are often ‘false breaks’ of support and resistance, which we can use to trade. (more on this later)

• Price action usually gets us into most trades, so don’t be too concerned about becoming an expert at identifying swing points and support and resistance. You just need to be aware of the levels and patterns that form near them. Learn to plot them on the chart, always.

• It is not hard to realize by simply glancing at a chart, that horizontal levels in the market guide everything.

• The Bulls team are attacking up the chart, while the bears are defending and push them back down the chart. The area where bears are defending are “resistance levels” (try line)

• When the Bulls cross the “resistance line” (score a try), they then pull back and try to score again.

• The Bears team are attacking down the chart, while the bulls are trying to defend and push them back up the chart. The area where the bears step in to defend are “support levels” (try line).

• When the bears cross the “support line” (score a try), they then pull back and try to score again.

• The ‘Pointy bits’ after each wave in the market are knows as swing points.

• When a market makes higher lows and higher highs it is up trending, and when it makes lower highs and lower lows it is down trending.

• Old support becomes new resistance, old resistance becomes new support.

• Draw horizontal lines through relevant levels.

• To enter trades with High probability.

• To place protective stop loss

• To place limit order to take profit (target areas)

• To expect a change in market conditions or trend.