RichardCox

Understanding the Coppock Curve First introduced by Edward Coppock in the early 1960s, the Coppock Curve (CC) is an oscillator that was originally designed to alert traders to potential shifts in an underlying market trend. For most of its history the CC has been used to send signals in long-term strategies in the major stock benchmarks. But these tools can be applied to all asset classes in any time frames as a means for generating trading signals and establishing new market positions. Design and Calculations “When Coppock was originally working on developing the indicator most of his focus was centered on price activity on monthly charts,” said Sam Kikla, markets analyst at BestCredit. “So for traders with a longer-term perspective, the CC might prove to be highly effective.” For the most part, CC trading signals are relatively infrequent when using monthly charts so for those looking to be more selective about their positions, this is an approach that has clear advantages. For those looking to identify a larger number of trading signals, this can be accomplished by moving down to a daily or hourly time frame. In generating its signals, the CC uses a weighted moving average of an asset’s Rate of Change (ROC). This essentially means that the CC is a momentum indicator that will fluctuate and oscillate around a zero line (below and above the line). The CC is composed of three variables: a Long ROC interval (14 periods), a Short ROC interval (11 periods), and a weighted moving average (default is usually 10 periods). The number of periods is essentially an indication of the number of candlesticks used in determining the value of each CC component. To calculate the CC, we take the sum of the Short and Long ROC intervals (11 and 14 periods) and then take a 10 period weighted moving average of that sum. The mathematical formula for the CC looks like this: CC = 10-interval weighted moving average of the 14-interval ROC + 11-interval ROC Calculations for the ROC look like this: ROC = [(Interval Close - Interval Close N periods previous) / (Interval Close N periods previous)] x 100 For the CC, the N variable used in the ROC calculation can be substituted by 11 and 14 (the interval period for the Short and Long ROC measurements). Two individual ROC calculations are taken. Once plotted on a chart, the oscillator looks like the chart graphic shown below: The CC Trading Strategy The key aspect of the CC is the zero line. This is the region that acts as a trigger for trading signals. A positive bias (for long positions) is seen when the CC is moving above the zero line. Bias is negative (for sell positions) when the CC falls back below the zero line. Alternatively, the oscillator can also be used as a tool for knowing when to take profits. For example, long positions should be closed if the CC turns negative. Short positions should be closed if the CC rises into positive territory. We can see a live example of this in the chart below, where green arrows show instances where the bias is bullish and red arrows show in cases where markets have turned bearish. In the above chart, we can see that time perspective is the daily interval. If a trader was interested in receiving more trading signals (both bullish and bearish), the best idea would be to move down to an hourly chart. If a trader was looking to be more selective about the number of signals received, it would be preferable to move up to a weekly or monthly chart. Alternative Settings Of course, there are always additional options for changing the default settings. And when traders are looking to implement the CC in different time frames (i.e. weekly or lower), additional adjustments can help to fine-tune the indicator. When using the default settings on the lower time frames, entry and exit signals tend to happen somewhat late and this means that it is harder to capture most of the projected move. This also creates a greater potential for losses, so there is nothing wrong with adjusting the CC settings in order to capitalize on price moves on the lower time frames. Specifically, you can increase the speed of the oscillations in the CC by reducing the the level of your ROC variables. This will also give you a larger number of trading signals. If you raise the level of your ROC variables, the oscillations in the CC will slow and give you a smaller number of trading signals. If you want the CC to produce exit and entry signals that are earlier, you should decrease the weighted moving average. This change can also lead to a trading signals that are sent with greater frequency. Delaying these signals can help those that are looking for more confirmation that a signal is validated, and this can be accomplished by increasing the levels for your weighted moving average. Filtering-Out Poor Signals and Potentially Bad Trades Any indicator carries with it the potential to send out a false signal, so it is always important to look for ways of reducing these as much as possible. One strategy to filter out potentially false signals is to wait for signals that agree with the direction of the dominant trend. These are the situations that include the potential for creating the biggest price moves (and the greatest profits). The best way to accomplish this is to identify your signal and then to move up one charting time frame. For example, if you see the CC cross into positive territory on a daily chart, pull out to a weekly chart in order to make sure that the longer term trend momentum is also positive. If you notice that the CC starts to cross into negative territory, it is generally a good idea to close the position. But, for conservative traders, it would not be a good idea to reverse the trade into a new short position. Points to Remember To weed-out bad signals, it should be remembered that choppy price action can lead to multiple signals in both directions. This reduces the probability that each signal is giving you accurate information and increases the chances for a losing trade. For this reason, the CC is best used in cases where there is a clear trend that can be found in the market, as this will lead to more signals that agree with one another. It should also be remembered that the CC gives no exact indication of where stop losses should be placed. This, of course, does not mean that stop losses should be ignored but other methods (such as plotting a swing high or swing low) should be used as a means for determining where to exit a trade. If the CC reading does not agree with your open trade, that trade should be closed. But this approach is somewhat vague and should not be used as a substitute for using a hard stop loss. As a momentum oscillator, the Coppock Curve helps traders to identify shifts in long-term market trends. Many would argue that the tool is best used on monthly time frames, but there is a good deal of flexibility in place for the indicator to be adjusted with more specificity. For these reasons, it makes sense to test different settings with a demo account so that you are able to get a better feel for the Coppock Curve and match its strengths with your broader strategy approach.

Has the Trend Reversed? Or It is Ready to Resume? 3 Strategies to Know the Difference A wide variety of studies show that forex markets tend to operate in a trending fashion more than other classes (such as stocks or commodities). The reason for this comes from the fact that valuations in currencies are most closely tied to the broadest macroeconomic factors -- on both the national and global levels. These factors have less of an impact on assets like specific stocks. So for those that spend most of their time trading forex, trend analysis becomes much more important in determining your ability to generate consistent gains. The key questions for any trend-based trade center around the assessment of its cyclical position: Is an old trend ending? Is a new trend beginning? Is the trend in need of a correction (an oppositional move toward historical averages)? Is the previously established trend ready to resume after a correction has completed? Inaccurate to these questions result in losing positions. This means you will buy into an uptrend that is ready to reverse, sell a downtrend just before it begins making an upside correction, etc. There are many potential scenarios that could result in losing positions. So the real work when basing your decisions on trends comes from your work in determining which stage the trend has reached in its overall life cycle. This is obviously a broad topic, so the scope of this article will focus on one potential scenario, asking the question: Is the previous trend ready to resume? When an established trend is ready to resume, high probability positions can be taken and it becomes possible to capitalize on the underlying momentum that is present in the market. Here are three types of market events to watch. Understanding Corrections First, we must have an understanding of what a market correction looks like. This is the scenario that will need to complete before the trend can resume. In the first chart example, we can see a series of relatively minor downside corrections within a broader uptrend (shown as red arrows). “Market corrections are essential, because no asset can rise or fall indefinitely,” said Sam Kikla, markets analyst at BestCredit. “The market needs an opportunity to ‘take a breath’ and return to its historical averages in order to generate fresh momentum for prices to continue further.” These corrections allow traders to re-enter the market and establish new positions. These new positions are what enable valuations to continue higher or lower. Fibonacci Levels Validated The first chart example shows price corrections that are relatively random in nature. They are all of varying degree and follow no predictable sequence. Of course, there is nothing wrong with this, and this is the way most corrections will unfold as you are watching the trend. But when we add Fibonacci retracements to the equation, we can start to quantify the price lengths that will mark the smaller correction within the larger trend. I will not go into the intricacies of Fibonacci but I have written about some of these previously here. The most commonly watched areas when Fibonacci zones are plotted can be found at the 38.2%, 50%, and 61.8% retracements of the larger move. These levels are used to plot potential points of support (for uptrends) and resistance (for downtrends). In the chart example above, we can see the 38.2% Fibonacci level act as resistance in a broader downtrend. If this level did not hold, it would be a short-term indication that the downtrend could be over -- and traders would then begin to target larger corrections back into the 50% and 61.8% Fib levels (at least). In the example below, the 38.2% retracement does hold, and this then places the focus back on the previous lows that marked the measured move in the downside Fibonacci wave. Aggressive traders could have entered into short positions once prices started to fail at the 38.2% retracement. More conservative traders might want to wait until the longer term support level to break before committing to a position. In both cases, we have signals that the longer term trend is resuming. Consolidation Breakouts: Triangles and Ranges Consolidation Breakouts in the direction of the previous trend mark the second way of determining whether or not the previous trend is in place. Consolidation points are essentially periods of indecision in the market. There is not enough available information for the majority of traders to be swayed in one direction or another. But these periods cannot last forever. When consolidation patterns eventually do break, the break tends to be forceful and decisive. The market has likely received the information it wanted and now prices are ready to make a strong move. When this happens in the direction of the original trend, the signal is more valid as it is supported by the already established momentum of the prior trend. In the example above, we can see that an uptrend has established itself with a strong series of higher highs. This is followed by a period of sideways consolidation that is marked by a decreasing range of constricting support and resistance levels. This gives us the Triangle formation that will be important in determining whether or not the original uptrend will be able to continue. In this example, the breakout is to the upside, and this would be an indication that long positions can still be taken as a way of capitalizing on the broader trend. Next, we look at range-bound conditions, where the support and resistance levels are not constricting and sideways trading dominates. Breakouts from these patterns tend to be less forceful. This is because a greater tightening of market energy is required to form a triangle but these are important patterns to watch nonetheless. The chart above shows another bullish scenario, where prices enter the range from the bottom (in an uptrend). Prices test both sides of the range multiple times before breaking to the upside. This confirms that the original bullish trend is still in place and that long positions can still be established. Elliott Wave Completions For those unfamiliar with the basics of Elliott Wave patterns, I have written previously about the main structures here and here. For the purposes of this article, we are mostly concerned about the corrective A-B-C periods, as these points mark the levels where the trend will either resume or begin to fail. A-B-C patterns do not require prices to be trading within a constrictive range, so this allows traders to spot new instances of trend resumption when a Triangle or sideways range is not present. In a bullish scenario, we would want to see a structure similar to what is pictured above. Prices begin to correct to the downside after an uptrend, hitting point A before rising to a lower high at point B. Prices than fall below point A to carve out new support zones at point C. This is the critical area, however, as we will need to see prices turn upward here in order to confirm that the broader uptrend is still in place. If this does not occur, avoid new long entries. If prices break above the B point, the correction has ended and the uptrend should resume. Conservative traders might wish to wait before the highest high is broken in order to confirm long position entries. More aggressive traders will enter after the B point is broken, as this signals the downside move was only a short term correction. Here, the conservative trader would receive more confirmation before entering the trade. The aggressive trader would be able to capitalize on a better (lower) price level. As with any strategy, these ideas can be combined and in the chart above we can see an example of prices hitting the C point in a corrective Elliott wave move just as prices have also completed a 50% retracement of the original uptrend. A bounce out a zone like this creates a highly bullish scenario as you are receiving multiple signals that are all in agreement. So, while most of the examples above are bullish, the same rules apply when downtrends are seen (just in reverse). In all of these cases, traders can use the market’s information as a way of assessing whether or not the broader trend has completed. These events can form the basis of a new bias for trade positioning.

3 Ways to Confirm a Breakout Breakout strategies are some of the best-known and most commonly used approaches in the forex markets. But these strategies carry with them an elevated level of risk, as roughly 70% of these occurrences fail, and are not accompanied by sustainable follow through. When buying a breakout, the trader is buying high. When selling a breakout, the trader is selling low. This, of course, is a scenario that is far from ideal -- and if stops are not properly managed, losses can begin to accumulate quickly. But this does not mean that breakout strategies should be avoided altogether. There are many successful technical analysis traders that swear by these types of approaches and it is clear that when conducted appropriately, breakout strategies can be an easy way of generating long-term profits. The key is to find ways of separating the good breakouts from the bad breakouts. In all cases, we will need to enter into positions that are likely to continue in the direction of the break. This means you will need some way to confirm the breakout before placing your trade. Here, we will look at three ways to validate a breakout, so that new positions can be established. Finding Optimal Market Conditions The first step is to identify situations where markets are showing the right conditions for a sustainable breakout. One of the best ways of doing this is to find periods of consolidation, where prices are trading in a tight range that does not reflect what is typically seen in the currency pair. For example, an historically volatile pair can be seen in the GBP/JPY, as lower liquidity levels tend to produce moves that are sharp and extended. We could use an indicator like the Average True Range (ATR) to determine whether or not the current conditions match what tends to be seen over longer periods of time. ATR readings that are abnormally low cannot last very long, and will often precede a violent breakout. In the chart below, we can see an example of what this might look like: (charts created using OT Trend) In the example above, we can see that prices have moved into a tight trading range that is uncommon from an historical perspective. ATR readings are well below normal, and this should send a big signal to traders that the current market conditions are unlikely to last for very long. Any break from this range (up or down, the direction makes no difference) will be more likely to see follow-through -- and this means that higher-probability positions can be taken if a breakout occurs. Fundamental Reasoning Technical traders tend to avoid fundamental reasoning when looking at technical analysis strategies. But when looking at breakouts that follow periods of consolidation, there are clear fundamental reasons for why sustainable rallies or declines might occur. Think, for example, of the Non Farm Payrolls economic release. The report is always released on a Friday and the early sessions of the week are almost always characterized by reduced trading activity and tight trading ranges. This is because traders are generally unwilling to commit to large positions before the data is made public. The more important the data, the lower the trading volumes before the data is released. The more important the data, the greater likelihood a new trend will develop once the economic report is made public. So, there are reasonings here that extend beyond simple technical analysis -- and this supports the validity of new trade entries. Clearly Defined Support/Resistance Levels The next component that is needed before establishing high-probability breakout trades can be seen in clearly-defined support and resistance levels. Of course, these price zones can be highly subjective -- and two traders can look at the same chart and identify completely different trading ranges. For these reasons, it makes sense to rely only on support and resistance levels that would be clear to the majority, and avoid those that are not immediately visible. Let’s look at the example trading range shown in the chart below: The validity of a support or resistance level is often determined by the number of times that level has been tested. In this example trading range, the support zone has been tested four times, while the resistance level has been tested only twice. This would essentially mean that a break to the downside would be more likely to generate follow-through then would a break to the topside. Price Closes and Avoiding Breakout Failures (Bull Traps and Bear Traps) Once the breakout does occur, it becomes critical to watch the next price close. Hourly and Daily charts tend to be the ones that are most commonly watched by the market, so if you see prices close above the resistance level (for bullish breakouts) or below the support level (for bearish breakouts) on an hourly or daily basis, there is a much better probability that a new trend has developed at the breakout point. This means positions could then be taken be taken in the direction of the breakout. If these directional price closings to not occur on the chart you are watching, it is a warning signal that a bull or bear trap is in place -- and that the original breakout was not valid. This means that new positions should not be taken, or that positions should be closed if they have already been established. By their very nature, breakouts should be forceful, momentum-filled events that continue without the presence of any immediate corrective moves. If this does not occur, it is just a better indication that the market has gotten ahead of itself and that the original range is simply getting wider (not actually breaking). In the chart example below, we can see an instances where a trading range experiences a false break (bull trap). In this example, we can see an example of a bull trap, as prices break above previous resistance, only to reverse lower later. In this case, prices close the time interval in the region of the resistance level after correcting from recent highs. The following price candle actually shows a Doji candlestick formation (a reversal signal), and then prices decline back below support. This, of course, would have resulted in losses for any traders that had established long positions based on the initially resistance breakout. But without significant follow-through (and the reversal candle that followed), the trader should have considered closing the position in order to avoid a bull trap. Conclusion: Watch for Consolidation, Clear Price Levels, and Favorable Closings Before Entering into Breakout Trades Of course, breakouts strategies will not only apply to sideways trading ranges. Trend line breaks and Channel breaks will also fall into this category. But all of the rules remain the same, and there are three critical elements that should be in place before any breakout positions are established. Specifically, it is important to exercise patience before placing any trades -- and this can be difficult given the fact that markets might begin to move quickly. This can create a psychological mindset that propels you to enter into a trade in order to avoid missing the next big trend. But these are the cases where it is perhaps the most important time to proceed with caution as breakout trading can quickly turn and create massive losses. This is because breaking trading requires us to buy high and sell low. But losses are not an inevitability and if the wait to see our three breakout requirements, the overall trading probabilities can be increased dramatically. With a period of consolidation, clear-defined support and resistance levels, and favorable price closings (in the direction of the break) we have a recipe for breakout trading that is likely to outperform. This type of approach can allow traders to get into the market in the early stages of a trend and to capture large sections of the move in the process.

Fibonacci Overlaps The plotting of Fibonacci retracements is one of the most commonly used methods in technical analysis trading. In most cases, traders will use Fibonacci levels in conjunction with moving averages or indicators that give overbought / oversold readings. Since a retracements essentially marks a “pause” or correction within a broader trend. These types of readings can give traders a strong signal that the correction has run its course and that markets are now ready to begin resuming the broader trend. This tends to be an effective way to base trading positions but it should be remembered that there are other ways of using Fibonacci levels, as well. Fibonacci retracements can be placed in more than one location (tracking more than one price move). In instances where these multiple plots show agreement, you can gain access to support and resistance levels that are made more valid (from the additional confirmation), and this can lead to higher probability trades. Brief Overview Derived from numbers in the Fibonacci sequence, Fibonacci retracements refer to support (in an uptrend) and resistance levels (in a downtrend) that are based on percentage corrections of the broader trend. Commonly watched retracement levels include: 23.6%, 38.2%, 50%, 61.8% and 100%. Retracement activity is important because prices can never rise or fall indefinitely, and Fibonacci levels allow traders to spot areas where those corrective moves might stall and reverse. Below, we have examples of the general structure for how Fibonacci retracement activity might unfold: Improving Probabilities But one concept that many technical traders fail to grasp is that these retracements do not need to be plotted in isolation. Furthermore, viewing these moves singularly can even be called a mistake, given the fact that the plotting a price move is highly subjective. That is to say, two traders might look at the same chart and see two completely different price moves as being most important. This, of course, would lead to different price levels (for support or resistance), and then these traders would be entering into positions at two different values. Which trader is right? Which trade has the highest probability of generating gains? The answers to these questions is, of course, difficult to quantify. But the answer can be found with the trader that is able to capture the best sense of what the rest of the market is watching. Let’s say hypothetically that Trader A is plotting a retracement using a move in the EUR/USD from 1.3250 to 1.3375, while Trader B is plotting a retracement using a move from 1.32 to 1.3375. If a larger section of the market is using 1.32 as a starting point, then Trader B is more likely to complete a successful trade. Fibonacci Overlaps: Plotted Examples But what about using multiple price moves? This is best done when using more than one time frame, and a common approach is to combine hourly and daily charts for short-term strategies or daily and weekly charts for those that prefer to enter into longer-term positions. Below, we can see a bullish and bearish example of this type of occurrence: The bullish example above shows two plotted moves. The short-term move is drawn from around 700 to 1900. The longer-term move is drawn from below 300 but the same peak is used at 1900. This is often the case when two separate moves are plotted, as it is often easy to find a major top or bottom that is clearly defined. But this does not have to be the case, you could use completely different tops and bottoms in your analysis, as well. In the chart above, we next consider the most important question: Do we have enough evidence to establish a trade in the direction of the bullish trend? In order to establish a long position, we need a solid level of support and at least one indicator reading that suggests the potential for more upside. A 50% retracement means that prices have risen or fallen in an amount equal to have of the originally plotted price move. For the short-term charted move, this would mean that prices will drop back into the 1300 region. Does this 1300 level have a corresponding area in the longer-term move as well (the move from below 300 to 1900)? In the Fibonacci measurements shown above, we can see that 1300 is also the 38.2% Fib retracement of the longer-term move. This suggests that the 1300 area is a dual support level, and is likely to contain prices from falling further to the downside. In addition to this, we have an indicator reading that suggests oversold prices. Since we are seeing agreement in multiple areas, we can come to the conclusion that high-probability long positions can be taken near the 1300 level, with stops just below. Next, we look at a bearish example of the Fibonacci overlap. In order to establish a short position, we need a solid level of resistance and at least one indicator reading that suggests the potential for more downside. In this example, we again have two plotted price moves that are used to make our Fibonacci calculations. The longer-term move begins near 4.00 and extends downward to 3.00. The short-term move begins at 3.8 and then extends back down to the same range low at 3.00. This creates a tiered structure of Fibonacci resistance zones that can be used to establish short trades. Of course, the strongest levels will be seen at instances of agreement between the two moves. One such area can be found just above 3.4, which is shown as an orange bar in the chart above. In this example, however, the zone really marks a range -- as the 50% retracement of the longer-term move can be found at 3.45, while the 50% retracement of the shorter-term move can be found at 3.42. This suggests that short trades can be taken anywhere inside this range. In addition to this, we have a bearish indicator reading (trending downwards), and the agreement of all these factors suggests that high-probability short trades can be taken while prices hold below 3.45. Stop losses would be placed just above this level, as any upside violation here would render the resistance zone invalid. Conclusion: Capitalize on Multiple Sections of the Market Fibonacci support and resistance levels are used by a majority of technical traders, at least sometimes. But in most cases, these levels are not as “solid” as they could be. This is because Fibonacci calculations are generally made in isolation. Wouldn’t it make more sense to use these levels in combination? The fact remains that you will receive fewer trading signals and be out of the market for longer periods of time. But this also means that the trades you actually to take will have much higher probabilities for gains, as there will be more validity to the support or resistance levels you choose. One of the central benefits of this approach can be seen in the fact that not all traders operate on the same time frame -- but this does not mean that traders with different perspectives will necessarily be trading off of different price levels. There will always be cases where a trader using a daily chart will be watching the same price zone as the trader that is watching an hourly chart, but neither will know this is happening. When we combine larger and smaller price moves within a trend, there is a greater chance that we will be able to capitalize on these occurrences when they do happen. For these reasons, it makes sense to look for Fibonacci overlaps and place your trades if you have at least one added indicator reading that agrees with your analysis.

Thanks for the comments I do disagree with the idea that leading indicators exist at all, so I don't have a problem looking at tools that categorize what happened in the past.

Trading with Fractals One of the central discussions that is had in market internet forums involves the validity of technical analysis and whether or not it should be used at all when compared to fundamental analysis. A large part of these discussions deal with arguments suggesting that markets are random, and cannot be predicted using historical price activity. The popularity of this debate has helped authors like Burton Malkiel rise in popularity. Malkiel’s A Random Walk Down Wall Street essentially argues that investing in the financial markets can be done with no greater probability than throwing darts at a dartboard. But while there are many valuable truths in Malkiel ‘s assertions, the underlying belief that markets are inherently unpredictable can be quickly disproved by the large number of traders that successfully employ price strategies and are able to generate gains on a consistent and long term basis. Do Historical Patterns Actually Exist? Those that disagree with the idea that markets are random and chaotic will often cite the tendency for markets to unfold in patterns and then proceed in a way that can then be predicted with a certain degree of probability. Price patterns give traders the ability to identify the underlying trend, the strength of that trend, and the likelihood with which that trend is likely to extend or reverse. One relatively simple way traders can assess these trends is to use fractals, which can deconstruct the larger trends and point out potential reversal patterns. So, what exactly is a fractal -- and how can it be used in active trading? Fractals Defined The traditional use of the term “fractal” deals with mathematics and chaos theory. But the term can be applied to the financial market as well, given the fact that it is a non-linear, dynamic system. Traders tend to simplify these ideas when moving in and out of active positions, and see fractals as periods of minor retracement within larger trends. A tutorial for adding the fractal indicator to your MetaTrader platform can be found here. The spatial structures themselves consist of five or more price intervals (or at least five candles on a candlestick chart). These price periods must then meet the following criteria: Bullish fractal reversal points are found when the pattern low is surrounded by at least two higher lows on both the right side and left side. In the example below, the fractal itself is shown as a red arrow. Bearish fractal reversal points are found when the pattern high is surrounded by at least two lower highs on both the right side and left side. Finding Tops and Bottoms with Lagging Indicators Traders that argue against the use of fractals might cite the fact that they are lagging indicators. In order for the fractal pattern to complete itself, we will need to see reversal activity in at least two price periods. For example, in a bullish reversal prices need to rise for at least two time intervals. This means that there is no way to place a trade entry at the lowest low before the uptrend begins. But the fact remains that most true reversals will need more than two time intervals to unfold -- sometimes many more than two. This means that fractal reversal strategies are excellent structures for those seeking strong risk-to-reward ratios, as stop losses can be placed just outside of the reversal structure. And even with the delay of two time intervals, an extended reversal will create a scenario where you can still place a trade entry while most of the new trend remains intact. Related Indicators In practice, traders rarely use the fractal indicator on its own. One related indicator that combines the use of fractals along with moving averages is the Alligator indicator. In the chart below, we can see that buy signals are sent when prices are able to break above the Alligator teeth (the center line in the moving-average cluster). Sell signals are sent when prices break below the Alligator's teeth. See below: When combining indicators, the traditional rules of technical analysis require us to play to the strengths of all available tools and to weed-out conflicting signals (i.e. avoid placing a trade). If we are using fractals along with the Alligator indicator, we will need to see a fractal signal that agrees with how prices are behaving relative to the Alligator reading. So if we are looking to enter short positions, we would need to see a bearish fractal form as prices start to penetrate the Alligator teeth from above. The reserve would need to be true in order to initiate buy positions. Essential Elements From the link above, we can see that it is relatively easy to install a fractal indicator on your charts and then to spot the patterns once they develop. But there are some essential elements that should be remembered when actual trades are being placed. Since a fractal is a lagging indicator, it is a good idea to use them as a way of confirming outside signals. This will help you to understand whether or not a true reversal is actually unfolding -- and whether or not a trading position should actually be taken. Time Frames In this article, we reference “time intervals” but this is just a fancy way of describing the single plotted price points in your charts. If you are using an hourly candlestick chart, this is one price bar (wicks included). But fractal techniques are most effective when dealing with broader time horizons. So if you are using a daily or weekly price chart, your fractal signals will indicate the potential for a more reliable reversal. Traders with reduced time availability tend to operate using the broader time frames and the added advantage here is that you receive fewer signals that have higher probabilities for accuracy. It is also important to use more than one temporal perspective when you define your bias. This means multiple charts for the same asset. What is happening over the hourly interval? What is happening over the daily interval? Your chances of trading success will improve if these areas agree with one another. But there are also contrarian arguments that can be made when the longer-term perspective disagrees with the short-term view. If markets are up this week in a long term downtrend, it makes sense to take advantage of your environment and start to build selling positions (and vice versa). Conclusion: Fractals Should be Used as Confirmation for Established Trend Signals Situations like these are where fractals can be great for active traders that already have an established bias. If you see a fractal on your chart when you have a prepared trading strategy, its usually time to pull the trigger as you will be given your confirmation. It is most important to remember that fractals should be used as potential reversal signals. This means that fractals can be used to either open or close positions. For example, if you are currently buying an asset, it might be a good idea to close the position if you see a bearish fractal form as the Alligator indicator is suggesting a potential move to the downside. So these tools can be used in dynamic ways in multiple strategies, and they should not be viewed as unilateral indicators that have only one application.

Trend Lines: How to View Your Charts - Part 2 In part one of this article, we looked at some of the central elements involved when drawing trend lines and identifying how that majority of the market’s momentum can be visualized on your charts. This included factors such as reading your charts from right to left (when finding important support and resistance points), watching price and time in combination and proper trend line construction. Here, we will look at some additional market events (such as support turned resistance / resistance turned support) and the Demark system, which is another method for using trend lines in live trades. Support Becomes Resistance, Resistance Become Support For traders that are more traditionally focused on strategies like range trading, clearly defined support and resistance levels become essential for generating high probability trading ideas. Areas of support are price locations where buyers have stepped in and demand exceeds supply (sending prices higher). Areas of resistance are price locations where sellers have stepped in and supply exceeds demand (sending prices lower). These levels do not need to be static, however, and this is why a downtrend line can also be described as a resistance line, while an uptrend line can also be described as a support line. This is important to remember because it shows that trend lines can be viewed in ways that are similar to static support/resistance points. This also means prices would be expected to behave the same way when these events occur. So, when an area of resistance (or a downtrend resistance line) is broken, that area would now be expected to work as support going forward. Of course, the reverse would be true for broken support trend lines. In the graphic below, we can see a clearly defined downtrend line that acts as price resistance on three separate occasions. On the fourth test, demand overcomes supply and prices rise to new short-term highs. But any declines are limited, as prices are contained by the previous downtrend line below. Prices test this level once again and bounce -- confirming that the downtrend has run its course. Buy positions could have been taken as resistance has now turned into support and propelled prices higher. Sell positions can be established in the reverse scenario (an uptrend line is broken, and then acts as resistance on the following test from below). Defining the Levels Most Important to the Market Support-turned-Resistance / Resistance-turned-Support events are important for a variety of reasons. In addition to helping us identify levels where trade entries can be placed, these events also tell us which price zones are most important to the market. For example, if the EUR/USD has consistent trouble rising about the 1.25 mark, a major event would occur if this level was later broken. If 1.25 starts to then act as support (market bears have difficulties pushing prices lower), we would then know the level that concerns most of the market. This is critical for determining sentiment, as we would then know that the market has turned bearish (when prices are below this “line in the sand”) or has become bullish when prices are above. Demark Trend Lines When researching technical analysis techniques, there are several names that pop-up over and over again. One of those names is Tom Demark, and a good portion of his work is dedicated to working specifically with trend lines. Demark’s work forms the basis for many other systems (such as the Mouteki system), so it makes sense to have an understanding how Demark’s approach when choosing your own methods. For Demark, it is critical to have a system for defining support/resistance in order to maintain consistency. Of course, any trend line will require you to connect at least two resistance points (for a downtrend line) or two support lines (for an uptrend line). Generally speaking, a greater number of connected points means a more valid trend line -- and one that will be watch by a larger portion of the market. Here, we will summarize Demark’s trend line system, so that you can draw them yourselves on the charts. First, we must have a common definition of the terms “swing high” and “swing low.” In uptrends, a swing high exists at the upper wick of a price candle that is above the wicks of the price candles that come before and after it. In downtrends, a swing low can be seen at the lower wick of a price candle that is below the wick of the candles that come before and after. The structure of a swing high/low can be seen in the graphic below: For Demark, however, there are important distinctions to be made with respect to the number of relevant price candles that surround the swing high/low. For example, the graphic above would mark a Level 1 price point for Demark, because there is one candle on each side of the high/low that matches Demark’s criteria. If the example showed two candles on each side of the high/low, we would have a Level 2 price point, and so on. The greater the number of candles on each side of the high/low, the more significant the price point. Higher level points are the best ones to use when finding chart areas to connect with your trend lines. Rules for Drawing the Trend Lines Given these rules, we can start to look for areas in which to plot the most stable and accurate trend lines. Uptrends: Focus on the bottom wicks of the candles and find the most recent swing low (reading your chart from right to left). Moving backward in price history (moving left on your chart), find the next candle in line with higher wick lows to the left and right. Continue with this approach until there are no more swing lows that meet the criteria (the bigger the number of swing lows, the better). Draw a line connecting your identified price points, starting from the right of the chart to the left. The left-most point on your chart will be the lowest point in the series, and your trend line will ascend. Finally, extend the trend line from your right-most swing low (the highest swing low) and extend the line to the end of your chart using the appropriate angle. Downtrends: Focus on the upper wicks of the candles and find the most recent swing high (reading your chart from right to left). Moving left on your chart, find the next candle in line with lower wick lows to the left and right (the surrounding price periods). Continue until there are no more swing highs that meet the criteria. Draw a line connecting your identified price points, starting from the right of the chart to the left. The left-most point on your chart will be the highest point in the series, and your trend line will descend. Extend the trend line from your right-most swing high (the lowest swing high) and extend the line to the end of your chart using the appropriate angle. Conclusion: Trend Lines are Subjective -- But We Can Remove Some of that Subjectivity Trend lines make an important part of most technical trading strategies. But many traders run into problems when there is a lack of discipline and too much inconsistency with respect to obeying your regular trading rules. Innovators like Tom Demark have offered ways of structuring your trades, and this approach has evolved into later strategies like the Mouteki system and others. Most broadly, it should be remembered that trend lines will generally serve the same function as traditional range highs/low in that the will work as support/resistance going forward. But the key difference lies in the fact that trend lines give us the added information of time, where traditional range high/lows only give us price projections.

Trend Lines: How to View Your Charts - Part 1 When we begin to watch price charts and learn technical analysis strategies, one of the first things traders will start to do is draw trend lines. But one of the earliest difficulties arises when traders become unsure with respect to how these trend lines should be drawn. The undeniable fact is that plotting trendlines is a highly subjective practice. What one trader sees as an uptrend or downtrend could be interpreted differently by another trader. Even the same trader could look at an identical situation on two different days and draw different conclusions. This ultimately means that developing a system that remains consistent and uniform is impossible to achieve. There are no “correct” trend lines but some plots are able to capture the essence of the markets momentum better than others. So, it is important to focus on strategies that allow you to properly construct your trend lines so that you can have a more accurate way of viewing the market’s trajectory and take some of the subjectivity out of the equation. Ultimately, you will need to be able to arrive at clear definitions of trend line breakouts and determine price projections so that you can establish profit targets for your positions. Understanding Trends From a basic perspective, it is essential to have an understanding of what makes an uptrend or downtrend. When supply consistently exceeds demand, markets will experience bearish trends. When demand consistently exceeds supply, markets will experience bullish trends. These are the forces that create the market environment, and we can make visual representations of these activities using ascending slopes (increased demand) and descending slopes (increased supply). But when attempting to draw specific trend lines, difficulties arise when choosing the exact highs and lows to connect. This is where subjectivity enters the picture and this can prevent traders from seeing what is actually going on in the market. Additional difficulties can arise from the fact that most traders are simply plotting from left to right on the price charts (going from past to present). The problem here is that not all time periods are created equal, and this approach fails to understand the more recent time intervals carry more weight than those further back historically. This is also the issue when dealing with things like an Exponential Moving Average (EMA) versus a Simple Moving Average (SMA). There are specific reasons why most experienced traders choose to use EMAs. Market conditions are constantly changing, so the most recent price information is what is going to give the most updated reflection of market sentiment. Trend Line Construction These factors can complicate the process of drawing trend lines. We are taught from an early age to read from right to left, but this does not need to be the case when we are assessing price charts. When looking to construct proper trend lines, it is important to develop patterns and strategies that conform to consistent practices. When regular practices are carried out in an imprecise way, we will sometimes see traders drawing multiple trend lines for the same move on their charts. The lack of commitment in constructing a single trend line can make it impossible to clearly define the trend or to plot specific areas for stop losses, profit targets, and trade entries. In all cases, we must select at least two price points to connect when drawing a trend line -- but a bigger number of connected support/resistance points can help to confirm the validity of the trend line. For downtrends, these price points will mark resistance areas that decline over time. For uptrends, these price points will mark support areas that rise over time. But what most traders miss is the fact that these price points can be identified by looking from right to left. Of course, longer time frames produce more stable constructions than shorter term time frames. Consider the 4-H chart below in the EUR/USD. Price momentum has been positive in recent sessions, and this means we will need to find support points to connect when defining the trend line. Below, we can see four support areas (reading from right to left): Here, we can see demand levels increase (demand is exceeding supply) and these areas create the uptrend. The chart below shows these four price points connected with an uptrend line: The green line in the picture should now be viewed as the “demand” line, and we will expect prices to find support in this area going forward. The demand line becomes invalidated if we see an interval close below this line. Of course, the bearish scenario would show the reverse: Notice in these examples that it is not necessary to perfectly connect the tops and bottoms of each set of price points. There will almost always be be cases where your trend line do not connect the support and resistance levels perfectly. It is not even necessarily desirable that these areas form a line that looks 100% perfect. Looking for these situations will only keep you out of trades that would have otherwise been successful. All you are trying to do here is assess the real trajectory of the market so that you can define your bias and place trades that are in-line with how the market is likely to unfold. Another important point to note is that we are categorizing the right-most point as (1), because we are looking at the chart from right to left. Price Targets and Stop Losses When we are looking to buy low and sell high (as high/low as possible), look to place your trade entries close to your supply/demand line. The reason for this lies in the fact that out trend line is the only information the market is giving us, and we will need to use this information to its best advantage. We do not want to see prices blow through trend lines, so it is important to see these areas tested first before entry. Once the market hits these areas and reverses, you have confirmation and can establish a trading bias. For conservative traders, all you want to do is take your profits at the market’s previously established highs. For those with a more aggressive strategy, it is often the common practice to set profit targets above previous highs (or below previous lows) as the presence of a trend creates an increased probability that prices will extend beyond their previous ranges. In stop losses, conservative traders will generally want to set their trade exit above/below the trend line, because it is important to close the trade in cases where your your trend line is invalidated. The reason for this lies in the fact that your original trading idea was wrong and you need to close out before things get worse. All we have in technical analysis is the early information the market gives us. If this proves incorrect, accept it and move on. Those with more aggressive strategies will generally want to bring their stop losses to break-even once the previous support/resistance level is tested. Price and Time The next idea to consider is the fact that trend lines give us an idea of how to trade in terms of price levels and time intervals. This would be another area where new traders (and most traders) fail to understand the market environment. Trend lines give us two pieces of information -- not one. Slopes have an X and Y axis. This involves two variables, the second of which is time. So, when we are able to draw trend lines we are ultimately able to assess the dominant direction in which prices are likely to travel. We are also able to assess the length of time that will probably be needed in order for prices to reach certain highs or lows. In part 2 of this article, we will look at additional factors (i.e. support becoming resistance) as well as the Mouteki System which is another way of using trend lines as part of a trading strategy.

I am not sure I would categorize 2013 as the Year of the Taper. We saw only minor reductions in stimulus and even that was only 2 weeks before 2013 came to a close.

Hi, thanks for the comments. If there are specific topics you are interested in, let me know and maybe we can cover them.

Trading the 1-2-3 Reversal Getting the best price on your trades (whether they are long or short positions) will generally depend on your ability to spot reversals in trends. Markets tend to work in extremes, as the “dumb money” tends to pile onto trend momentum when it is ready to reach its exhaustion point. This final push that is driven by traders that are late to the party should be viewed as an opportunity, however, as this creates excellent opportunities for those looking to establish contrarian positions. The key word here is “reversal,” as this suggests that prices have become too cheap or too expensive and are ready to change course. Those that can spot the earliest signals in these changes are the traders that will be able to best capitalize on the new trends that come next. There are many ways of assessing when a trend has run its course. For example, some traders might look at an indicator like the Average True Range. This tool gives us a sense of how far (in pips) a currency pair is likely to travel over a given period. Once this range is exhausted, it is unlikely that prices will be able to travel further. Other common strategies can be seen in overbought/oversold indicators (such as the Relative Strength Index), which signals instances where prices have deviated too far from their historical tendencies. For candlestick traders, there is a three-candle reversal pattern that is often referred to either as an evening star (for sell signals) or a morning star for (buy signals). The basic rules for these structures can be found below. Evening Stars - Essential Criteria for Sell Signals: The second price bar posts a higher low, and higher high when compared to the first and third price bar. The first price bar is bullish (posting a higher close, relative to the open) The third price bar is bearish (posting a lower close, relative to the open) Morning Stars - Essential Criteria for Buy Signals: The second price bar posts a lower low, and lower high when compared to the first and third price bar. The first price bar is bearish (posting a lower close, relative to the open) The third price bar is bullish (posting a higher close, relative to the open) The 1-2-3 Reversal Defined For those that like to focus more on price activity itself, we can look at a longer term variation of the candlestick reversals shown above. Here, we will look at the 1-2-3 reversal pattern, which presents a stable price structure that is easy to identify. The basic 1-2-3 reversal is composed of two simple price structures but there are many variations that can be identified depending on how market activity unfolds prior to and as the reversal pattern is progressing. Next, we look at the basic criteria for the buy and sell signals, using the 1-2-3 reversal pattern. First, it is important to view the 1-2-3 reversal for what it is: The end of an old trend and the emergence of a new price direction. Once an extreme market move has taken place (bearish or bullish), prices will then retrace the previous move with a larger-than-normal price length. In the next charted example, we can see that prices push lower, and find a bottom at point 1. Prices then correct in an upward fashion, finding initial resistance at point 2. After some downward stalling, prices then break the short term resistance level defined by point 2, and surge higher (this is the larger-than-expected retracement). It is important to note, however, that the pattern only remains valid if a higher low is established at point 3. If support at point 1 is re-tested, you are not seeing a 1-2-3 reversal. Breakout buy positions can be taken once resistance at point 2 is violated. In a downtrend, we would not typically expect to see breaks of important resistance levels, and this is the first indication that the original downtrend has completed. In an uptrend, the reverse would be seen, as prices would begin breaking closely-watched support levels, without re-testing upside resistance at point 1. This can be seen in the structure shown below. Breakout sell positions could be taken once prices violate support defined by point 2. In both cases, stop loss levels could then be defined by the support/resistance levels at point 3. Live Chart Examples Now that we can see the “bare bones” structure, lets look at some live chart examples. The first step in the process is to determine the overriding trend, and then draw a trendline to define that trend. In a downtrend, we start from the swing high (labeled C in the chart below) and continue to the price low (labeled A). Once this trendline breaks to the topside, we can identify point 1 (which is the trend low), and the price pattern has now started. The live chart below shows a defined downtrend, a corrective reversal at point 1, a small downward move to point 2, and finally a break of point 1 resistance, which is the move that defines point 3. Buy orders can be set above resistance (the new higher high at point 1), which stop losses set below point 2. Reversals in Uptrends Next, we look at reversals in uptrends that present opportunities for short positions. We first must define the uptrend with a upward trendline (starting at C and ending at A in the graphic below). Once prices fall below the upward trendline, we have our origination area at point 1. The reversal has now begun. The live chart below shows a defined uptrend, a corrective reversal at point 1, a small upward move to point 2, and finally a break of point 1 support, which is the move that defines point 3. Sell orders can be set below support (the new lower low at point 1), which stop losses set above point 2. Conclusion: The 1-2-3 Strategy Allows Traders to Bet Against the Dominant Trend as it Ends In these articles, I often about the commonly used market maxim “the trend is your friend, ride it until it ends.” To be sure, this little gem holds a great deal of wisdom that can be used to capitalize on the market’s overriding momentum in a way that is easy to spot on your price charts. But we must also remember that trends cannot continue forever, and if we can spot instances where a trend has exhausted itself, there are some excellent opportunities to get into the new trend at highly favorable levels. There are many different ways to determine whether or not a trend has completed. Some of the most common techniques involve the implementation of tools like the ATR, RSI, or candlestick patterns. The 1-2-3 reversal pattern offers something of a variation on these techniques and should be viewed as preferable for those that prefer to place most of their focus on price action itself. There is no rule that says some of these strategies cannot be used in combination, however. So, for example, if we were to see a bullish 1-2-3 reversal pattern as prices have fallen into oversold territory on the RSI and prices have reached the lower end of their projected range using an ATR indicator, we would essentially have a “perfect storm” scenario for new buy positions in your currency pair.

Hi Dave, thanks for the comments. I do agree that picking tops and bottoms can be some of the most difficult parts of the business, tripping up a lot of traders that are not ready to cut positions when necessary.

3 Ways to Get Back into a Trend The most commonly used phrase in technical analysis is that “the trend is your friend, do your best to ride it to the end.” The reason for this comes from the fact that most forex traders are looking to capitalize on the underlying momentum of the market. The fact remains that the forex market is the largest and most liquid market in the world, so siding with the majority has some clear advantages. In addition to this, trends are very easy to identify. Trend spotting can be done by traders even in the earliest phases, as we are essentially just looking for higher highs and higher lows (in an uptrend) or lower highs and lower lows (in a downtrend). One of the biggest problems with trend trading, however, is that the market has already made its move before most traders are able to identify the trend. This can lead to the need to move on unfavorable entry points, where you are buying when prices are elevated and selling after major declines. Is there any way to remedy these difficulties? Is it possible to both capitalize on the market’s underlying momentum and avoid entering into the trend at extreme levels? Here, we will look at three methods for accomplishing this. Buy Low, Sell High or Ride the Trends -- or Both? For full disclosure, most of my own trading is done using contrarian strategies. Generally, I am looking for situations where market moves have become extreme, and then I start to move in the other direction. But I also base a good deal of my trading decisions on fundamentals, and this means there is often a need to go in the direction of the majority trend. I look to bridge the gap between these two approaches (when necessary) by simply waiting for corrective moves within that trend. Here, it is important to understand that the term “corrective moves” suggests that prices essentially need to retrace some of their prior moves and get closer to their historical averages. I will not get into the details of each of the three strategies that follow, as this has already been done in many other articles. Instead, I will discuss the ways these three technical analysis techniques relate to broader trend activity, and can be used in trades that capitalize on the market’s underlying momentum at relatively favorable prices. Mean Reversion First, we look at reversion to the mean, which basically describes the tendency for market prices to eventually move back to their historical averages. Here, the “mean” can literally be anything, as it is entirely defined by the user. Some traders focus on shorter term moving averages, and plot a 10-day, 20-day or 21-day moving average on their charts. Longer term examples typically include, the 55-day, 100-day, or 200-day moving averages. In most cases, traders will use two or three different moving averages, as this can provide additional trading signals (upward or downward crossovers, for example). The first chart graphic shows prices in a downtrend, with prices rising back toward the moving average. The conventional wisdom suggests that the market’s bias remains bearish as long as prices hold below this moving averages. But the instances where we rise back toward the moving averages should be viewed as a renewed opportunity to sell the asset. Of course, warning signals would be sent if prices broke sharply above the moving average and many traders would opt to close the position if that were to occur. But we long as the market momentum remains negative, trend traders will be able to get back into the negative trend when prices correct upward. This will create the added benefit of allowing you to capitalize on minor rallies while still being supported by the broader bearish momentum seen in the markets. Of course, these methods apply to bullish markets, as well. But in those cases the market price will be seen holding above the moving averages, and the new buying opportunities will be seen when prices drop back to test moving average support from the topside. Fibonacci Retracements Fibonacci retracements use calculations based on the numbers in the Fibonacci sequence to identify potential turning points once markets have made corrective moves. There are many different Fibonacci levels that can be plotted on your charts, but the measurements that are most commonly used can be seen at the 38.2%, 50%, and 61.8% retracements. To get an idea of what these percentages mean, let’s hypothetically assume the USD/JPY rose from 0 to 100, and then dropped back to 38.2. This would mean prices have retraced 61.8% from their highs, and this would then be referred to as the 61.8% retracement of the move from 0 to 100. The underlying momentum in the market is still positive, but this drastic pullback in price activity creates new buying opportunities for those looking to buy. Below, we can see the basic structure for bullish turning points based on Fibonacci retracement levels. In a bearish scenario, these structures would be flipped upside-down. Now, we will look at how these retracement are used on live charts (also using a bullish example). In the chart graphic below, we can see prices that begin an uptrend at point A, stall at point B and retrace 61.8% of the original bullish move. This area marks the entry point to buy the asset, giving you a much lower price while still having the benefit of the broader uptrend. Support Turned Resistance Last, we look at support turned resistance levels (and resistance turned support levels). The main logic here is that a price breakout occurs as market sentiment shifts, but markets still end to obey the same levels that were previously important. This occurs because most of the market have based their positions on these levels. If prices break a key resistance level, that same zone can be expected to act as support when tested in the future. If prices break a key support level, that same zone can be expected to act as resistance when tested in the future. These events can be viewed as being similar to a Fibonacci retracement, except for the fact that the areas to watch are based on historical supply and demand areas, rather than Fibonacci calculations. First we have a bullish example, with prices showing an upside breakout, strong follow-through and then a corrective move back to the initial resistance zone. This area now acts as support (shown by the purple line). Buy positions can be established in this area, as the majority of the market’s momentum is positive. Prices are more favorable, however, as we are now seeing a downside correction. Next, we have a bearish example, with prices showing a downside breakout, strong bearish follow-through and then a corrective move back to the initial support zone. This area now acts as resistance and is tested two times (a larger number of tests strengthens the argument for the level’s validity). Sell positions can be established in this area, as the majority of the market’s momentum is negative. Prices are more favorable, however, as we are now seeing a upside correction. Conclusion: Capitalize on Market Momentum, But Do it at Better Prices It is clear that most traders (especially new traders) are focused on market trends and are looking to trade in the same direction. But this type of approach can create problems when there is no opportunity to buy lower and sell higher (thus, obtaining a better price in your trade). This limits prospects for gains and creates the potential for excessive losses if markets change unpredictably. One way of guarding against this is to use corrective retracements. This method will allow you to benefit from the market’s momentum and gain an advantage relative to your peers, as long as you are patient enough to wait for areas where preferable entry points can be found.

Alternative Chart Applications: Understanding the Hurst Exponent As traders move into the more advanced sections of their technical analysis education, it becomes important to start to look at some alternative indicators and oscillators that can be used to help you get an edge on the rest of the market. One example of a chart application that has been getting more attention in recent years is the Hurst Exponent, which is now used as a way of calculating market predictability and likely outcomes in price activity. Perhaps most interesting is the fact that these calculations were originally made for areas that are completely unrelated to price activity in the financial markets. In its earliest studies, the Hurst Exponent was used in hydrology to assess appropriate dam levels near the Nile river, and protect against the volatile rain and drought seasons that are historically prevalent in the region. So, the main question is this: Can mathematical studies that have proven useful in unrelated areas of science actually be applied to technical price analysis? Some traders would argue that it makes no sense to use tools that were not developed specifically for the financial markets. After all, there is real money at risk and the use of unrelated tools could make trading outcomes unpredictable. Proponents, however, would argue that the financial markets are simply a small part of a much larger universe and that mathematical rules that hold true in one area will remain constant in others. And since the Hurst Exponent can be used as a chart plugin and be calculated using available market data, it makes sense to take a look at its relative elements that can be used and applied to forex trading. The Hurst Exponent Defined In relevant equations, the Hurst Exponent is typically denoted as H and gives us an understanding of the level of predictability in price behavior. The exponent fluctuates between values of 0 and 1. Values below 0.5 indicate “anti-persistence” in the time series, which essentially means that a bullish price movement is likely to be followed by bearish price movement (and vice-versa). Hurst values of 0.5 suggest markets will be characterized by Brownian motion, which essentially implies random price movements. Hurst values above 0.5 indicate “persistence,” which is a suggestion that market trends that are currently in place are likely to continue. All of this information can be used to identify the potential for markets to show “persistence” in trending activity, as it gives us an understanding of the level of predictability that is currently in place. The first graphic example shows the Hurst Exponent live in MetaTrader. In this instance, the reading shows activity at the 0.5 midpoint which indicates market predictability is at a minimum and trades should be avoided. Trading Strategies Once we understand how the Hurst Exponent reading can give us an idea of whether or not current market conditions are likely to continue, it should be understood that this information can prove highly valuable when we are looking to construct trades. Drilling down to the basics, buy positions could be established when the Hurst value is well above 0.5 and a bullish candle reforms on our charts. This Hurst reading would indicate “persistence” and increase the probabilities for success in buy positions. Bearish positions could be taken using the same indicator reading, but in this case we would need to see a bearish candle or clear evidence a downtrend is already in place. In cases where the Hurst reading is well below the 0.5 level, a condition of anti-persistence is in place and this lets traders know that current market conditions are likely to change. In this case, we would want to sell after bullish candles or uptrends, and buy when we see bearish candles or downtrends. To sum up, trades using the Hurst Exponent can be undertaken using the following steps: Plot the Hurst Exponent based on the market’s price activity Identify the reading’s position, relative to the important 0.5 “line in the sand” Find the market’s sentiment in the current price candle (bullish or bearish) Alternatively, current market conditions can be assessed using moving averages or trend readings Trade accordingly, given the directional rules listed above Limitations in the Hurst Calculation Skeptics of the Hurst Exponent application in the financial markets might cite the fact that there is no way to precisely calculate its value. Instead, all we can do is estimate the coefficient. At its core, the Hurst reading is a linear regression slope that is determined using a series of logarithmic data points (a larger number of data points will generally give a better reading). Most of the available indicator plugins will use the previous 1,000 bars as the primary data set for the indicator reading. Skeptics might note that the usage of 1,000 bars might mean that your latest reading might not be an accurate assessment of the current market situation. Another point to remember is that the Hurst value is constantly fluctuating, and this might lead traders to exit positions prematurely. Of course, the 1,000 data bars will not need to be kept constant. Fortunately, for those looking for variations even within the indicator itself, there are many plugins for MetaTrader that take care of these calculations for you. There are many different choices available on the internet (some are fee-based, others are free). One place a free download for the MT4 plugin can be found is here. So, as long as you understand the basic rules for interpreting applying the signals sent by the Hurst Exponent, it is entirely possible to start using the reading as a tool for confirming/rejecting your trading ideas. Conclusion: The Hurst Exponent is a Valuable Tool for Confirming Trade Positions Once we start to enter into the “advanced” stage of our trading education, it become important to start looking beyond the basic indicators (such as the MACD, RSI, of Stochastics) that are commonly used by a majority of the market. The Hurst Exponent is most useful as a confirming tool, as it gives you a sense of the level of predictability currently present in the market. If you are looking for a currency pair to buy, you will want to locate something with clear bullish momentum (using candlestick patterns, proximity to moving averages, or trend readings) and the highest possible H value (indicating market persistence). Bearish conditions would need to be in place for short positions, but you will still want a very high H value before committing. So, if you are typically using trend-following strategies, a Hurst exponent reading near the 1 level can prove to be a highly valuable confirming factor. For contrarian traders, you will want to see Hurst readings in the opposite direction. A reading well below 0.5 suggests that market conditions are likely to reverse (anti-persistence). So if you identify a currency pairs that has seen a long term uptrend, it might be a good time to sell. Using the Hurst Exponent as a contrarian tool will also give you the added advantage of being able to buy low and sell high (something that is not possible with the higher H value readings). In addition to all this, it should be remembered Hurst Exponent readings near the 0.5 level suggest that market predictability is difficult (or impossible) to assess. In these cases, it makes sense to stance on the sidelines and look for higher probability opportunities.

Taking Your Lumps: How to Properly Manage Losses One problematic characteristic that typically exemplifies the mentality seen in new traders is the sole focus on gains and the minimization of losses. These types of behaviors are not entirely surprising, given the fact that we do get into the trading business in order to make money -- not lose it. But what might not be readily apparent early on is that the only way to make sure that your account balance is growing is to properly manage your losses and not disregard the effects those losses will have on your broader averages. The fact is that losses are inevitable, and that it is simply not possible to trade without seeing some negative trades. In fact, there are many successful traders that lose money in a majority of their trades. But how is this possible? How could a trader that sees losses more than 50% of the time be successful? The answer lies in the fact that these trades earn much more in their positive trades than they lose in their negative trades. In short, these traders are able to properly manage their losing positions. Accepting the Reality of Trading First and foremost, we have to accept the realities of the market. Losses are unavoidable, and a single loss can erase multiple gains if not managed properly. Consistent profitability requires an accurate assessment of how each structured trade will impact the trading account. Common errors are made when traders hold onto a position too long, hoping markets will reverse and the trade will return to break even. But this mentality breaks the first rules of trading because there is no way to hold off losses indefinitely. Unexpected Impact of Holding Losers While it might seem like a great idea to avoid losses at all costs, losing positions will often build because of the underlying momentum in place in the markets. If you took the position in the first place, you probably had an argument for why an adverse move would be unlikely. Furthermore, you were probably not alone in your assessment and when prices moved too far too fast, all of the traders in that were wrong are not being forced to exit their position. This only adds to the markets momentum -- and compounds your losses in the process. For these reasons, there are situations where a string of gains is actually bad for the trading psychology, as this can create a set of unrealistic expectations. If you actually start to think that all of your trades can be successful, you will be less likely to close trades at a loss. If you refuse to accept the reality of the market, it is not out of the realm of possibility that a single trade to destroy your entire trading account (depending on your leverage and position sizing). Is Your Strategy the Problem? In many cases, losing positions have nothing to do with flaws in your trading strategy itself. You could have a perfectly sound system that is accurate most of the time, but just did not fit current market conditions. Your job is to spot the instances where the market’s price behavior does not match the strategy -- and then take your lumps and cut the trade. If you do not follow this mindset (and learn how to lose) your chances of achieving long term profitability are almost non-existent. Prediction vs. Probability Another mistake traders make is thinking they can know for certain where markets are headed. But could this same mentality apply to any other aspect of life? Can you be certain the Dodgers will win the next World Series or that next week your city will experience a snow storm? Of course, the answer is “no,” and trading is no different. What you can do in these situations in determine your forecast with some level of probability. Are there good odds the Dodgers might win the next World Series? Perhaps. Is there a strong chance your city will see snow storms next week? I think we are now starting to see the appropriate mindset. Averaging Down: Adding to Losing Trades Another issue occurs when traders discuss the “opportunity” to add to losing positions at the preferable prices currently seen. This is also referred to as “averaging down,” as it allows you to improve on your overall entry price. It must be remembered, however, that you are adding to your position size in the process and that if prices continue to move against you, the losses will actually be larger than they would have been if you did nothing. To be fair, averaging down can help in some cases and even turn your loser into a winner. But this doesn’t mean that it is always a good idea. The real issue is whether or not market conditions have turned. If you plan on averaging down, you will need some fundamental or technical reason for why you believe prices will turn back into your favor. Without this, it does not make sense to average down and the position should just be closed. As a basic example, let’s assume you entered into a long trade in the EUR/USD because it was in an uptrend. If prices start falling, breaking important support levels, and failing to post new higher highs and higher lows -- your initial reasoning behind the trade has been removed. This would not be an instance where you would want to average down. Watching the Data There have been many published studies that show traders actually win a majority of their trades. So, why are most trading accounts closing with margin calls or $0 balances? To answer this, we have to take a look at our account histories and look at the specifics of each trade. Essentially, this means that your trading “batting average” is not everything. The proportional value of your winners and losers is what really matters. On average, if you win 9 trades that earn $10 each, and then have 1 trade that loses $100, you will not have a future as a trader. Rules to Remember In addition to all of these factors, traders must always remember to have an active stop loss in place. While this might seem overly basic, there are many traders that try to use manual stops or will simply close out a position when they “feel it is necessary.” This is not good enough, and these practices can put you in positions where your losses have accumulated faster than you expected. This creates a snowball effect where you might be reluctant to accept the reality of the situation and close the trade at a loss. Stop placement should be automatic, and no position should be left open without one. This does not mean the stop loss cannot be moved later, it simply means that you have defined a parameter where market activity could invalidate your initial rationale. Methods for closing your position can come from a variety of different strategies. Many traders use significant support and resistance levels as an area to define when to get out of the market. In other cases, traders use technical indicators (such as the Average True Range) or set a position limit relative to their account size -- for example, never risking more than 2-3% at once. Closing your position does not have to be based on such hard and fast rules, however. Instead you could base things more closely on your strategy (as in the uptrend example discussed above).

This is the last chart graphic, I wasn't able to upload 8 pictures at once.

Gaining Perspective with Measured Price Moves Since the term “measured price move” can be applied in multiple contexts, it makes sense to examine its basic definition so that newer traders are not confused when the discussion topic arises. At its core, a measured move offers technical analysts an aid in forecasting future price moves after a clearly defined chart move has been idnetified. For example, a “chart move” can include things like the completion of a price pattern or a impulse wave in a trend. Let’s use an ascending triangle as our charted example (see the first attached graphic). Typically, when an ascending triangle (a continuation pattern) is seen, prices are expected to continue travelling in a bullish direction once the pattern’s resistance area is broken. The chart example shows prices violating resistance and continuing to the profit objective for long positions. But how is this level determined? And how to we know how many pips away from entry to place are take-profit orders? The answer lies in the measured move that precedes the break of resistance. Figure 2 shows a more detailed example with successive ascending triangles and the “pole” that represents the price distance in the initial impulse move. If this price distance equals 150 pips, the profit target will then rest 150 pips above the breakout point at the flag resistance line. In short, the size of the initial pattern is proportional to the size of the move that is expected to follow. History Repeating Itself The logic behind these theories is similar to what supports technical analysis as a whole: The idea that market activity is predictable as history tends to repeat itself. In addition to this, measured moves often correspond to a larger trend, where the market’s momentum is expected to re-assert itself with characteristics that exhibit relative equilibrium. Consider Figure 3 where prices have formed an uptrend channel beginning at point A. Once resistance is hit at point B, prices retrace (correct) some percentage of the move AB before reversing at point C and resuming the uptrend to point D. Note the similarities in structure, angle and distance in lines AB and CD. Gaps In other cases, potential price moves can be measured and projected when gaps in market valuations are seen. These events occur when, for example, markets are highly illiquid or when a significant news event changes the underlying bias that was previously in place. There are not enough active buyers or sellers to ensure stable price progression, so markets gap above or below to reach an area where there are enough buyers or sellers to contain prices. Figure 4 shows a bearish price gap. In these cases, the market’s perception of the value of the asset is being altered. To measure the next projected move from the price gap in an uptrend, we must find the price distance from the trend low to the middle of the upward price gap. This height is then projected to the upside, as shown in the structures in Figure 5. Watching Price and Time But while measured moves are typically thought of as simple movements in price, there are important time considerations that should be factored into the equation as well. The reason time is often overlooked here is because traders tend to be focused entirely on profits and losses once positions are open. But there is more to market activity than simple price action. Time scenarios have a tendency to repeat themselves as well, and this phenomenon can be extremely useful when looking to identify trading setups. So, when we are measuring projections within a trend move, it is important to note not only the number of pips prices have traveled but the amount of time it took markets to reach the measured level. This is done most easily using the similar trajectory angle on a single time frame. In Figure 6, we can see that the USD/CAD is showing positive trend momentum, with upswings of 410-470 pips in 15 and 16 day time intervals. So, while the relationships here are not exact, there are some striking similarities that should be noted. Of course, prices cannot travel in a bullish trend for an indefinate period, and markets will always need periods of reverse correction. This follows in the same chart, with prices falling 365 and 380 pips over 18 and 19 day periods. At this stage, we can start to see some of the characteristics that mark the uptrend in USD/CAD. Once prices start to turn up again, we will then have some idea of how far prices are likely to extend. When making our projections for the next measured move, then suggestion here is that prices are likely to travel somewhere in the neighborhood of 440 pips over the next 15 days. Constructing an Uptrend Channel Projection In Figure 7, we can see another example of an uptrend in the S&P 500. For those with technical analysis experience, this structure might look familiar as an uptrend channel, as prices continue to post higher lows and higher highs. First we will focus on the upswings, as this is where the majority of the market’s momentum is centered. In the first two impulse moves, we can see that prices have traveled 150 points in 22 and 24 days. This was followed by an incongruous move of 109 points over 16 days. So, when prices hit uptrend channel support, it would not be a prudent idea to set profit targets a full 150 points away, as there is now evidence of slowing momentum. Instead, traders would look for an average of these moves, and look for a profit zone that is approximately 130 points from the next swing low. In Figure 8, we can see a more complete uptrend channel composed of measured moves. Using the GBP/USD, prices start with positive impulse moves of 620-695 points over 12 and 13 day periods. Downside corrections within the uptrend channel are smaller in length and shorter in time. This would have to be the case, by definition, given that an uptrend channel will require the majority of the price action to be bullish. Bearish sub-moves (corrections) are seen in 5-6 day intervals with pip moves of between 290 and 330 pips. In this case, there are some warning signals that the uptrend channel might be over, as there is a double top formation. But, without this (or if prices break above this double top), the measured move would be something in the region of 660 pips over a 12 day period. This target should also fall roughly in line with the channel resistance zone. Conclusion: Measured Moves can be Used as an Aid in Setting Profit Targets Measured moves can be a valuable tool for traders in determining the likely extensions of major trending moves in the market. Trends are characterized by extreme changes in momentum, and in these cases it can be difficult to know when or where (price level) those a trend is going to run its course. If we do not know when a trend will complete, it is nearly impossible to set a profit target that can capture the majority of the action. Measured moves help to resolve these issues. In all cases, it is important to watch the elements of price as well as time, as these factors work in conjunction with one another and can help you to gain a more accurate reading of when and where a major turning point will be seen.

Divergences and Hidden Divergences Divergences between indicator readings and actual price activity allow traders to identify situations where trending moves are likely to complete. This is valuable information for contrarian traders looking to “buy low, and sell high” as evidence of price divergence is often considered a leading indicator of what is likely to happen next in the market. Divergences occur when indicators fail to confirm higher highs (in an uptrend) or lower lows (in a downtrend). Some of the studies most commonly used to identify price divergences include the MACD, RSI, Slow Stochastic, CCI, etc. Here, we will look at some of the ways changes in momentum present themselves, as well as the differences seen in traditional and “hidden” divergences. Classic Divergences The type of divergence most typically identified is the traditional, or “classic,” divergence, which is an early indication of trend reversals. Bearish divergences occur in uptrends, as indicator readings do not match the higher highs in the market’s valuation. Bullish divergences occur in downtrends, as indicator readings start to rise even though price activity is making lower lows. Classic divergences suggest that a bottom or top might be forming in the market even before the actual price activity has reversed through important support or resistance levels. The first charted example shows the basic structure of a classic divergence. Note the differences between price momentum and the changing direction of the underlying indicator. The second charted example shows the bullish and bearish scenarios in a live chart. Hidden Divergences A twist on the divergence scenario can be seen in the “hidden” divergence, which is actually a continuation pattern and can, in many cases, be more effective in predicting future price movements. Similar to the classic divergence, hidden divergences are seen when prices fail to match the activity in the chart indicator. In a bullish hidden divergence the following requirements must be met. The third charted example shows the structural formation: ● Price activity is characterized as an uptrend ● Prices make a higher low ● Indicator reading shows a lower low In a bearish hidden divergence, the opposite characteristics are seen. The fourth charted example shows the structural formation: ● Price activity is characterized as a downtrend ● Prices make a lower high ● Indicator reading shows a higher high Hidden divergences are primarily useful for trend traders, as the occurence of this pattern signals that prices have made a corrective retracement in a larger trend -- and that the trend is ready to resume. The main benefit of trading with hidden divergences is that the majority of the market’s momentum is on your side, as you are trading in the same direction as the larger trend. This is a key difference between the hidden divergence and the classic divergence, and one that many new traders miss when looking to implement these strategies. The occurrence of a hidden divergence can also act as a confirmation that the original trend is still valid. Chart Examples with Hidden Divergences The next charted examples show bullish (5) and bearish (6) hidden divergences with a real-time chart. What is important to remember here is that commonly-used indicators (like the MACD, RSI, or Stochastics) should be viewed for more than just an identification of overbought or oversold conditions. There are important relationships that exist between the indicator reading and the price activity itself. Indicator readings are multi-dimensional and can be used in a variety of different trading strategies. With divergences, we are looking for disagreements between specific aspects of the available information and market reactions. Consider the bullish example in graphic 7. Here, the EUR/GBP has broken out of a tightly consolidated range and despite the upside breakout (and higher lows in price) the Stochastic indicator drops into oversold territory and makes a lower low. Since this type of indicator activity is atypical, attention should be paid. Long positions can be taken here, based on a few different arguments: We can see a bullish crossover in the Stochastics, the indicator is starting to move out of oversold territory, and the hidden bullish divergence suggests that the longer term uptrend is still in place. In terms of trade structuring, stop losses and profit targets should be based on the initial reasoning behind the bullish argument -- the validity of the uptrend. This means the trade should be stopped if there is evidence that uptrend has ended. One of the clearest indications that this is occurring would be if prices dropped below the swing low that preceded the upside breakout. For these reasons, stop losses should be placed below this low. When looking at profit targets, the ultimate assumption is that prices will continue making new highs until one of the initial arguments for the trade becomes invalidated. So, in theory, your ultimate profit target should be above the current trend high. It makes sense, however, to book partial profits just below the previous trend high and then move your stop losses to break even once this target is met. This is because there is still reason to believe the previous trend high could still act as resistance. The Rubber Band and Catapult Effects The underlying “power” in the hidden divergence rests on the fact that corrective moves within a larger trend will, at some point, need to catapult themselves back in the appropriate market direction. From a fundamental perspective, this often happens because most of the trend-based profit taking has run its course and the market events that created the trend in the first place still create an accurate representation of the asset’s appropriate market valuation. From a purely technical perspective, these occurrences show that the indicator reading has generated a larger trend pullback than prices themselves. The indicator will need to revert to its mean in order to stabilize. The necessity for mean reversion often creates a significant “snap-back,” and the added momentum that accompanies these moves is usually enough to bring additional higher highs (in an uptrend) or lower lows (in a downtrend). By definition, this means that the earlier trend is resuming and that the continuation pattern has provided an accurate signal. These trend-supportive changes in momentum are sometimes called the “rubber band” effect, or the “catapult” effect, as they are able to send prices into new regions. Conclusion: Indicator Readings are for More than Simple Overbought/Oversold Studies When new traders start constructing positioning ideas with technical analysis, one of the first things we see is the plotting of indicator readings. In most cases, these readings are used to spot places where an asset’s price has become overbought or oversold, and that new positions should be taken in the opposite direction. But when we look at classic and hidden divergences, we can see that indicators can be used in a multitude of different ways. Classic divergences are preferred by contrarian traders, as they suggest a trend is ready to reverse. Hidden divergences offer a different spin on this, and offer trend continuation signals before prices “catapult” themselves in the direction of the underlying price momentum. In both cases, it makes sense to watch your indicator readings in ways that most other traders are missing. Divergences offer one way to get this leg-up on the rest of the market.

New Patterns for Harmonic Traders Harmonic trading is not exactly a new approach to technical analysis. Its foundations stretch back nearly 80 years, when H.M. Gartley devised the trading structure (now known as the Gartley pattern) that would ultimately form the basis of the harmonic strategies undertaken by modern practitioners like Scott Carney. So, while Gartley’s original structure did not implement the Fibonacci price leg ratios that characterize the harmonic patterns used today, it is clear that harmonic trading is not a new phenomenon. If fact, patterns like the Crab, Butterfly and Bat have been tested extensively and have been shown to forecast future price activity with truly incredible probability levels. But what should be remembered here is that harmonic trading is a constantly evolving discipline. This should be evident in the fact that many innovative traders have developed the ideas originally presented by early pioneers like Gartley, and discovered many new patterns in the process. Here, we will look at some of the latest discoveries which might not be as well known as some of the structures listed above. But the Shark, Cypher, and Nen Star should also be considered as viable additions to any harmonic trading arsenal. Next, we will outline the structural parameters that define these newer patterns. Trading Harmonic Patterns First, it should be understood that there are important similarities when trading all harmonic structures. The commonly understood structure unfolds in four price legs, resembling an “M” shape for bullish patterns and a “W” shape for bearish patterns. These structures are marked by five price points: The X point marks the beginning of the structure, and this is followed by an impulse move to point A, a corrective move to point B, a trend-based move to point C, and then an extended correction to point D. Each of these moves will fall in line with a specific Fibonacci retracement. Different retracement levels will define different harmonic patterns. This D point is the structure’s critical area, as this is where the pattern has reached completion and is sending the signal to buy or sell the asset. This area is referred to as the Potential Reversal Zone (PRZ), where prices are expected to start moving in the opposite direction. The fact that these patterns culminate in the “Reversal Zone” should be a key indicator that these patterns are used to establish contrarian positions. Stop losses for these trades can be placed just above or below the PRZ, as one of the key advantages of the harmonic pattern is that it defines a price reversal with a high level of accuracy. This enables traders to keep stop losses relatively tight, as any violation of the PRZ suggests that the harmonic pattern is invalid and should not be used as the basis for a position. Since the Gartley is the foundational example of the harmonic structure, it is pictured in the first charted example (in both bullish and bearish reforms). Note the price points, Fibonacci ratios, corrective and impulse moves, and the expected reversal direction. The second charted example shows a bearish Gartley (W shape). The box above the D point is the PRZ, which is where a short position would have been triggered. The Shark Pattern Now that we understand how the patterns are traded, we will look at some of the most recently discovered variations on these patterns. First is the Shark pattern, which is a variation on the traditional M and W shaped patterns but follows the same general idea in producing trading signals. The Shark pattern is composed of two separate price segments: A Harmonic impulse wave that fails, and another Harmonic impulse wave that hits extreme levels. Shark patterns must be actively managed and possess pre-defined profit targets once positions are established. Support and resistance levels are defined by precise price ratios. The ideal Shark structure requires price moves that obey the 88.6% retracement parameters and the 113% reciprocal ratio. The pattern looks to capitalize on the excessive nature of the extreme harmonic impulse wave (relative to recent averages). In order for the pattern to remain valid, prices must immediately reverse at the completion point (point C), initiating the new trend. The diagrams for the Shark pattern will look different than most of the traditional harmonic patterns, because it is an emerging 5-0 pattern that is traded after point C. The pattern’s D point is actually the profit target, and is found at the confluence of AB=CD and the 50% Fib retracement of BC. Since the pattern is traded off of the C point, traders will need to actively manage these positions: The Shark pattern is not a “set it and forget it” type of structure. The next graphic examples show the needed price levels, first as a blank graph and then in real-time charts (first bullish, then bearish). Below you can find the pattern parameters that define the overall structure: ● Drawn from the initial 0 point, price travels to point X in its first impulse move (this move defines the needed price retracements that follow). ● Prices then retrace in a corrective fashion back to point A. ● Prices then extend further in the original impulse direction, to point B. This move will equal 113% to 161.8% of the initial impulse move. ● Volatility then picks up drastically, as prices reverse to point C. This move will be equal to 88.6% to 113% of the initial impulse move. This move will also mark 161.8% to 224% of move XA. ● Profit targets are defined by the move AB, which can also be found using the 50% Fib retracement of the move BC. The Cypher Pattern Next, we look at the Cypher pattern, which more closely resembles the traditional “M” and “W” patterns that have risen to prominence. The Cypher pattern unfolds in five points (X-A-B-C-D), with the buy and sell zone marked by the D point. Profit targets are then defined by the retracements that follow, and are based on the corrective move CD. As we can see in the next charted examples, profit targets can be dual in nature, with traders closing part of the position as prices hit the 38.2% Fib retracement of the move CD. Stop losses should then be moved to break even and the remainder of the position can be closed for a gain once prices hit the 61.8% Fib retracement of the same move (CD). A real-time example of a bearish Cypher pattern is shown next, and the pattern parameters are found below: ● Drawn from the initial X point, price travels to point A in its first impulse move (this move defines the needed price retracements that follow). ● Prices then retrace in a corrective fashion back to point B. ● Prices then extend further in the original impulse direction, to point B. This move will equal 113% to 141.4% of the initial impulse move. ● Volatility then increases, as prices reverse correctively to point D. This move will be roughly equal to 78.6% of the initial impulse move (XA). This move will also mark 127.2% to 200% of move AB. ● Profit targets are defined by the move CD. Profits should be taken as prices approach the 38.2% and 61.8% retracement of move CD. The Nen Star Pattern The Nen Star Pattern is sometimes confused with the traditional Bat pattern, but there are some important differences in their respective retracement structures. The next charted example illustrates the bearish Nen Star pattern. Below are the parameters that define the structure: ● Drawn from the initial X point, price travels to point A in its first impulse move (this move defines the needed price retracements that follow). ● Prices then retrace in a corrective fashion back to point B. ● Prices then extend further in the original impulse direction, to point B. This move will equal 113% to 141.4% of the initial impulse move. ● Volatility then increases, as prices reverse correctively to point D. This move will be roughly equal to 127.2% of the initial impulse move (XA). This retracement also separates the pattern from the Cypher structure. The final move will also mark 127.2% to 200% of move AB.

Structuring Trades: Know the Difference Between Stop Losses and Stop Limits Technical analysts are fully aware that protective stop losses are an absolute requirement before any real-money positions are taken. But many traders are unaware of the fact that there are different methods for setting these protective stop orders. Here, we will look at the differences between a stop loss order and a stop limit order. It is important for traders to understand these differences because they are widely unknown even though they are regular features in almost every trading platform. These protective orders can get traders in and out of the market without the placement of manual orders but there are some key differences that should be understood before looking for areas to enact both strategies. Traditional Stop Losses Stop loss orders can be broken up into two different types: the Sell-Stop order and the Buy-Stop order. Sell-Stop orders are used in long positions, set below the market price, and trigger a market sell order if prices reach a level that was previously unexpected or in some ways invalidates the strategy that inspired the trade in the first place. So, if prices fall below a certain level after you have opened a long position, a Sell-Stop order can be used to prevent further losses if prices continue to drop. Buy-Stop orders work in the same way (only in reverse) and are used when initiating short positions. Buy-Stop orders are set above the trade entry price and are triggered when prices hit that unexpected bullish level (invalidating prior expectations and the reasonin behind your trading strategy). Market Protection with Stop-Limit Orders Stop limit orders have much in common with traditional stop losses, but there is literally a “limit” that is placed on the execution price. When placing a stop limit order, two price levels must be identified: the limit price, and the price at which the trade is converted to a sell order. Here, it should be remembered that a limit order is an order to buy or sell an asset at a set price (or better). So, rather than seeing the order trigger as a sell market order, it instead becomes a limit order that executes once the limit price is reached. Time limits can also be placed on limit orders so that they are not triggered after a set expiration point. Because of these specific requirements, there is no guarantee the order is going to be filled and this is even more true when market volatility hits extreme levels. Stop-limit orders can be used when asset prices fall outside the limit, if the investor unwilling to buy or sell and instead wants to wait for prices to move back toward the limit price. For example, let’s assume we have a long position in the EUR/USD and prices never fall to hit the stop loss level. Since prices are steadily rising, the trader might choose to cancel the stop loss order, instead placing a stop limit order at higher levels. As a point of illustration, let’s assume the limit order is placed at 1.3050, with the limit placed at 1.30. If the EUR/USD drops under 1.3050, the sell-limit order will be live. If EUR/USD prices fall below 1.30 before the order is filled, that order will not be filled unless prices move back to the limit of 1.3050. In most cases, traders cancel limit orders when the stock price drops below the established limit price, as these orders were placed with the intention of reducing loss exposure when prices gaining in downside momentum. If a trader misses the opportunity to exit the market before volatility reaches extreme levels, that trader can wait for prices to rise again (not selling at the set limit) because there might still be scope for gains. If the trader is unable to exit the market at 1.3050 and prices drop to 1.30, the order can be canceled because if there is enough momentum later to bring prices back to 1.3050, then there could be scope for additional runs higher. Similar to buy-stops, buy-stop-limits can be used in short positions in cases where traders have enough patience and risk tolerance to wait for prices to drop if the buy entry is not made at a level at (or better) than the limit price. Pros/Cons of Stop Losses and Stop Limits Stop losses and stop limits offer trade protection for different types of market environments. Stop losses ensure that an order is filled. But since broker execution is ultimately what determines price levels for entries and exits, stop loss prices cannot be guaranteed. Highly volatile markets can create slippage and larger than expected losses but for traders that are not actively monitoring their positions, this approach does offer protection from margin calls. Stop-limit orders, on the other hand, provide guarantees for price limits, but not for the actual execution of the order. If market volatility reaches extreme levels, this can generate significant losses if markets move in the wrong direction without hitting the limit price. For example, a significant news story or data release, traders could be forced to absorb any losses contained in the area between the entry price and the limit order. Both stop losses and stop limits can be structured in terms of time limit, with either a set execution time as as a Good Til Canceled order (which offers more manual flexibility). Conclusion: Which Order Should You Choose? Making the decision on which order to choose means assessing possible risks relative to the current market environment. If the market is particularly volatile, stop limit orders have an advantage because of their guaranteed price levels (protecting against the enhanced possibility for slippage). If market prices fail to reach the limit (and the order is not triggered), the traders might then have to wait for prices to move back toward the entry level. Conversely, stop loss orders work best if sentiment changes and traders need a guaranteed exit for their positions. In these situations, the original motivation for taking the trade has been removed and there is relative certainty that the position should no longer be held. Stop losses are preferable here because a stop limit order could lead to larger losses if the order is not triggered. In all cases, stop placement is highly critical and there are various ways of determining where stop loss levels should be placed in your trades. Stop losses that are placed too close to the current market prices are vulnerable to being hit quickly before reversing back toward a favorable direction. So simple strategies (like placing stops slightly above resistance or below support) will generally require a more thought-out approach in order to avoid being stopped-out unnecessarily. Stop losses and stop limits offer trade protection in different reforms and can be used in both long and short positions. Stop losses offer guaranteed execution, whereas stop limits offer guarantee price levels. The decision to choose which type of order will depend on market conditions and your methods for managing risk.

Trading the Head and Shoulders Reversal Any successful technical analysis strategy requires us to buy before prices head higher (in long positions) or to sell before prices drop lower (for short positions). This reality has inspired common market maxims like “always buy low, always sell high.” But those of us with trading experience know that it is nearly impossible to forecast true trend tops and bottoms with any regularity. In most cases, we will need to see evidence that the underlying trend is changing before we can establish contrarian positions. There are a variety of ways to do this: Doji patterns, oversold indicator readings, trendline breaks, and Engulfing candlesticks offer some options. In my own trading, some of the best market reversals have been seen with Head and Shoulders patterns (which can also give bullish signals when reversed). One of the reasons I prefer to look for these patterns is that the structures are much more complex than some of the other reversal signals mentioned above. These patterns unfold over broader time horizons and require a much more specific series of events in order to validate themselves. I also believe that these patterns match the spirit of what technical chart patterns are truly meant to do: Visually represent changes in market sentiment. Normally, I try to stick to the facts in these articles and avoid personal opinions but here I thought additional disclosure was appropriate because this is one of my preferred ways to trade. Head and Shoulders Patterns Defined Head and Shoulders patterns signal bearish reversals in an uptrend (shown in the first charted example). Reverse Head and Shoulders patterns signal bullish reversals in a downtrend (shown in the second charted example). In these charts, we can see that prices form a peak in the direction of the previous trend (creating the left shoulder). This is followed by a retracement and then a larger push in the same trend direction (creating the head). Finally, we have one more retracement and a smaller push in the direction of the trend (creating the right shoulder). The pattern should resemble the “head” and “shoulders” on the human body, with each component beginning at roughly similar price levels. This region is then referred to as the “neckline.” Interpreting the Pattern In the standard (bearish) pattern, price behavior is telling is that markets are making an attempt to extend an uptrend, with two higher highs (the left shoulder and head). Warning signals are sent, however, when the third peak fails to create a higher high (creating the weaker right shoulder). At this stage, anyone in a long position should consider exiting the market as there is now building evidence of a reversal. The reverse Head and Shoulders pattern is bullish, signaling the opposite scenario as the right shoulder marks a higher low. Trading Triggers But the pattern can do more than send warning signals for those already in established positions. These patterns can signal new entry points as well. Let’s look again at the standard pattern. Here, we can see that the troughs between the shoulders and the head can be connected using a trendline. It should be remembered that this trendline does not need to be perfectly horizontal, but this line (the neckline) should be viewed as an area of important support. Once prices fall below this neckline support, the pattern is activated and it is time to enter short positions. In the third charted example, we can see a real-time chart Head and Shoulders pattern, where prices form the low peak/high peak/low peak series and break below the neckline. Short positions should be initiated once neckline support is invalidated. The Reverse pattern is used for long positions, and a real-time chart example can be seen in the fourth graphic. In this case, the neckline forms above the pattern, and acts as an important resistance level. Once this resistance level is broken, long positions can be taken as this implies a new uptrend is place. Establishing Price Targets, Setting Stop Losses To construct the complete trade, profit targets and stop losses must be established. In the third and fourth charted examples, the profit targets are drawn out. This is done by measuring the price distance between the extreme point on the head, and then moving back down to the neckline. So, for example, if this is 100 pips, your profit target will be 100 pips after entry (taken after the neckline break). More aggressive traders can elect to close half the position once this target is reached and then move the stop losses to break-even for the remainder. More conservative traders should close the entire position once the objective is hit. Profit targets are relatively clear in these trades. Stop losses are not as clear-cut and will actually depend, to some extent on the size of the profit target. For those with a low risk tolerance, stop losses can be placed 10-15 pips above the neckline (for short trades) or 10-15 pips below the neckline (for long trades). For those with a higher risk tolerance (or smaller position sizes), stops can be set above the right shoulder (for short trades) or below it (for long trades). Most important for stop losses, however, is to maintain a favorable risk-to-reward ratio. So, for example, if the profit target is 100 pips, your stop loss should be no more than 50 pips (2:1 risk-to-reward ratio). This also goes far to determine whether or not you should take an aggressive or conservative approach in these trades. Complex Head and Shoulders Last, it should be remembered that with any technical analysis pattern, there will always be some separation between actual practice and the pre-determined ideal. In some cases, the neckline will be flat, others not. Similarly, the number of shoulder can also vary. For example, when multiple left and/or right shoulders appear, the structure would be classified as a Complex Head and Shoulders pattern. In the fifth and sixth charted examples, we can see a sample structure of what this might look like. Two left and right shoulders are accompanied by the head formation before prices push through the neckline. The underlying reasoning behind these patterns is that the initial trend makes a series of highs and low that support the trend. But when this is followed by highs or lows that suggest a turning point, and an eventual violation of the neckline, a Head and Shoulders pattern is in place. This activity can be used to establish contrarian trades. Conclusion: Head and Shoulders Patterns Offer Reliable Reversal Patterns for Contrarian Traders For traders not readily familiar with the Head and Shoulders pattern, the structures should be considered as an added tool in regular trading. These formations make up some of the most reliable reversal patterns that can be found in technical analysis, and they become easy to identify once you begin looking. Added confirmation of pattern validity can gained using indicator readings, violation of Fib support or resistance levels, or price proximity to Moving Averages as a measure of underlying momentum.

Pros and Cons of Quant Trading Forex traders using technical analysis strategies as the basis for their positions will often run into practictioners of Quantitative techniques. This can easily open up a “can of worms” as there are some significant similarities between classical technical analysis and Quantitative strategies. The primary difference is that Quantitative strategies use automation to remove most of the human element, but even this characterization is not entirely true because all quantitative strategies are simply human-constructed technical analysis techniques that are triggered by computer signals. Here, we will look at some of the strengths and weaknesses of the Quantitative approach, so that technical analysis traders can decide whether or not these strategies are an appropriate addition to daily trading. Quantitative Trading Defined Quantitative strategies often implement a high-frequency approach, trading algorithms, and arbitrage positioning that is based on statistical averages. Many market analysts argue that Quant trading artificially adds to price volatility, because of the quick in-and-out positioning that has little or nothing to do with economic fundamentals. Some might not know that indicators and oscillators (such as the MACD or RSI) can also be characterized as Quantitative analysis tools, and this essentially means that Quant strategies and technical analysis are very close cousins. Trading opportunities are largely defined by probability -- mathematical computations that decide the chances prices will rise or fall based on current market events. Price, volume, and moving averages are common inputs used in trading models. In early computer trading Quant models were reserved for hedge funds and large financial institutions. But today, easily accessible applications like Trading Stations or MetaTrader are perfectly capable of executing Quant strategies -- and these methods can even be implemented from remote servers (meaning your personal computer doesn’t even need to be turned on to open and close trades). Common Strategies Quant strategies might seem new because modern computers can put incredible processing power in nearly every home. But the strategies behind even the most modern strategies have been in place for nearly a century. So just because you might see an advertisement for a “90% effective EA” doesn’t mean you are seeing a new and innovative strategy. If anything, it is probably the opposite. This can be true even for strategies that are back-tested. What worked in the past might give you no incite into what will happen next, which is a problem because this is what is truly needed to make profitable trades based on price behavior. Arguments Against Quant Strategies People selling Quant strategies as Expert Advisors (EAs) will, almost by definition, have techniques that have strong backtesting results. But if the markets were as simple as that, everyone would be a successful trader and the guy asking for change the street corner would have a penthouse apartment. Life -- and the financial markets -- don’t work that way. So, opponents of Quant strategies will argue that if you want to have confidence in your next trade you will need to monitor the actions of human beings, because human beings are what determine the net-worth of market assets. This is one of the reasons why many traditionalists label Quant EAs as “black boxes,” and it is beyond debate that there are just as many losing EAs as there are winning EAs. And when EAs fail, they tend to fail on a massive scale. One of the main reasons this will occur happens when market dynamics change, and historical events have no way of including future events. For example, when the Swiss National Bank enacted a price floor in the EUR/CHF at 1.20, market values in the currency pair rose by nearly 1,000 pips in a matter of minutes. There would have been no way for an EA to predict this type of event, so it would have been very likely you would have accrued losses if you were using an EA to trade the EUR/CHF (or any highly correlated forex pair) at that moment. Quantitative strategies can be constantly re-defined and streamlined to account for potential market occurrences, but the stark reality is that it would be impossible to account for all possible occurences in an EA. These strategies also tend to suffer when markets are experiencing above average volatility. In these cases, buy and sell signals are sent so often that rising transaction costs can significantly erode your potential for gains. Arguments Supporting Quant Strategies On the other side of the debate, the main strength of Quant strategies is that they operate using the highest level of discipline and objectivity. If your Quant model accurately forecasts what will happen in the market, your positions will use the available quantitative data to successfully exploit market inefficiencies and generate profits. Quant models can be composed of as little as one or two inputs (such as price activity relative to a moving average, or overbought/oversold readings on an indicator tool), or much more complex (which can mean thousands of inputs working in conjuntion with one another). Another benefit is that EAs are able to pick-up on trend activity as it develops. A running EA is constantly monitoring price activity and market scenarios to identify opportunities. Human beings are simply not capable of this level of attention or awareness. Quant models can be set to analyze large groups of assets simultaneously, whereas a person could monitor only a few at any given moment. These models will then rate scenarios in all cases, often using numeric or alphabetical grade levels (such as A-F, or 1-5). Assets with the highest ratings trigger long positions, assets with the lowest grade levels trigger short positions. This simplifies the trading process and allows traders to position themselves only in the most extreme cases (which offer the highest probability for gains). But Quant models are capable of doing much more than simply opening and closing positions. Trades can also be structured to account for proper risk levels (outlining stop losses, profit targets, and position sizing). Once trades are opened, it is also possible to limit exposure in correlated assets. For example, long positions in both the USD/JPY and USD/CHF would mean the account is taking on double exposure in the USD. Proper diversification is needed for any successful strategy, so it is important for those running Quant strategies through EAs to keep this in mind in order to avoid over-leveraging. Conclusion: Quant Strategies Offer Objective, Disciplined Trading But Also Create Added Risks Quantitative trading strategies have evolved significantly in the last few decades and have quickly changed from mysterious (potentially risky) entities to gain a much more accepted position in the markets. Gone are the time when these tools were available only to large hedge funds and financial institutions. Nowadays, anyone with a customizable trading station can run an EA and trade automatically with these signals. When deciding whether or not to use these tools, there is a spirited debate on both ends of the spectrum. Proponents will argue that EAs offer the most disciplined, objective approach to trading -- and this allows positions to be entered the moment major trend information develops. Opponents of these tools will cite added risks created when market events create trading environments that have not been seen before. In any case, Quant EAs are powerful tools and are not likely to be leaving the market’s presence any time soon. As always, it is important to test these applications with a demo account first in order to avoid making critical trading mistakes.

Essential Elliott Wave Patterns Pt. 2 In part one of this article, we look at four basic Elliott Wave patterns that are necessary for understanding and implementing this form of technical analysis. These patterns included Motive Waves, Diagonals (or Diagonal Triangles), Corrective Waves, and Double and Triple Zigzag patterns. It is important to have a firm understanding of the rules that govern these patterns, so if you have not yet read the first section of the article, you should do so now. This is important because this is the only way to ensure you will not be mistaking one of those patterns for the patterns discussed in this article. It is also important to have an understanding of the patterns in the first section because some of the rules for the following patterns build on the structures covered in part 1. Like all forms of technical analysis, there is some degree of subjectivity involved when identifying and using these patterns, so without an understanding of the rules of all Elliott Wave patterns, it would be unwise to place live trades based on this analysis. In the following sections, we will cover Flats, Double and Triple Sideways patterns, and Expanding and Contracting Triangles. This collection will round out the set of essential Elliott Wave patterns that will be needed in order to conduct this form of analysis. Flats In Flats, we have an Elliott Wave pattern that unfolds in a three-wave structure that proceeds in a sideways direction -- meaning there is no series of higher highs or lower lows, and instead looks more like a trading range. These patterns are labeled using the A-B-C format, and are corrective in nature. Since Flats move sideways, they are considered to be “counter-trend” as they do not agree with any bullish or bearish wave structures. Flats are one of the most common patterns in Elliott Wave analysis. The first charted example is a Flat. Notice the lack of directional movement, as it is essentially a sideways patter. Rules for Flat Formations: 1) Wave A is a corrective pattern that can take any form. 2) Wave B is also corrective pattern, and can take any form except that of a Triangle. 3) Wave B retrace at least 50% of the price movement that is seen in Wave A. 4) The price movement in Wave B is less than 2-times that of Wave A. 5) Wave C is either an Impulse Move or Ending Diagonal. 6) Wave C must cross into the price territory of Wave A. Double and Triple Sideways Double and Triple Sideways patterns (which are sometimes called Double 3s or Triple 3s) possess some similarities when compared to Flats. Typically, Double and Triple Sideways patterns consist of two or three corrective patterns that are connected by a joining wave. This joining wave is called an “x” wave. Double and Triple Sideways patterns are corrective in nature, but the Triple Sideways pattern is must less common. The labeling format for the Double Sideways is w-x-y. For Triple Sideways, the labeling is w-x-y-xx-z. In the second charted example, the Double Sideways (the more common formation) is shown. Note the dual A-B-C formations that are connected by the middle X wave. The third charted example shows the difference between the Double and Triple Sideways formations. Rules for Double and Triple Sideways Patterns: 1) Wave W is a corrective pattern but cannot be a Triangle, Double or Triple Zigzag or its own Sideways pattern. 2) Wave X is a corrective pattern but cannot be a Triangle, Double or Triple Zigzag or its own Sideways pattern. 3) Price moves seen in Wave X must retrace at least 50% of Wave W. 4) Wave Y is a corrective pattern but cannot be a Double or Triple Zigzag or its own Sideways pattern. 5) If Wave W is a Zigzag, Wave Y cannot be a Zigzag. 6) Price moves in Wave Y cannot be more than 2-times the price move seen in Wave W. 7) If Wave Y is not a Triangle, it must be at least as long as the price move seen in Wave X. 8) Wave XX is a corrective pattern but cannot be a Triangle, Double or Triple Zigzag, or its own Sideways pattern. 9) The XX Wave must retrace at least 50% of the price move seen in Wave Y. 10) Wave Z is a corrective pattern but cannot be a Double or Triple Zigzag, or its own Sideways pattern. 10) If Wave Y is a Zigzag, Wave Z cannot be a Zigzag. 11) The price move seen in Wave Z must be longer than the price move seen in Wave XX. Contracting and Expanding Triangles A Triangle is a very important Elliott Wave pattern that consists of a regular 5-wave corrective pattern, and uses the labeling format A-B-C-D-E. Since Triangles are corrective, it is important to remember that these moves run counter-trend. Triangles also operate within two channel lines (which are essentially shorter term trend lines) that drawn to connect waves A to C, and waves B to D. There are two types of Triangles: Contracting (sometimes abbreviated CT) or Expanding (sometimes abbreviated ET). Whether a Triangle is a CT or ET depends on the direction of the channel lines. When the channel lines move closer together, a Contracting Triangle is in place. When the channel lines move further apart, an Expanding Triangle is in place. Expanding Triangles are rarer than Contracting Triangles. The final charted examples show graphics that illustrate both forms. Rules for Contracting and Expanding Triangles: 1) In an Expanding Triangle, all waves must be a Zigzag, Double Zigzag, or Triple Zigzag. 2) In a Contracting Triangle: - Wave A can only be a Zigzag, Double Zigzag, Triple Zigzag or a Flat. - Wave B can only be a Zigzag, Double Zigzag, or Triple Zigzag. - Wave C will be a corrective pattern but cannot be a Triangle. - Wave D will be a corrective pattern but cannot be a Triangle. - Wave E can only be a Contracting Triangle, Zigzag, Double Zigzag, or Triple Zigzag. 3) The cross-section of the channel lines is seen past the end of a Contracting Triangle, and before the beginning of an Expanding Triangle. 4) The channel lines will always be converging or diverging. Essentially, these lines can not parallel or forming a range. 5) Only one channel line in a Contracting Triangle can be horizontal. 6) Neither channel line in an Expanding Triangle can be horizontal. 7) The end-point of Wave E must enter into the price territory of Wave A. Conclusion: Elliott Wave Patterns Build Off of One Another Elliott Wave theory works on the assumption that market psychology repeats itself in the form of wave movements that build into larger patterns. In this way, Elliott’s theories are somewhat similar to Dow Theory, given the fractal nature of both approaches to technical analysis. Elliott Wave theory dissects markets into much greater detail, however, as these structures can inwardly repeat themselves indefinitely. Impulsive Waves travel with the trend, and unfold in five-wave patterns. Corrective waves work counter-trend in groups of three and push prices back toward the mean. These 5-3 moves complete the trend cycle, but it is important to watch the specific rules of each pattern to ensure the validity of the overall analysis.

Essential Elliott Wave Patterns Pt. 1 To its critics, Elliott Wave analysis is an arbitrary, subjective, and ultimately inaccurate way of looking at price activity in the financial markets. But since many of these critics are not fully aware of the rules that govern these methods, it is clear that some of this disagreement comes a basic misunderstanding of the rules that govern the essential patterns. At its best, Elliott Wave theory signals instances where major market trends have reached an exhaustion point. When used correctly, this form of analysis can generate buy signals when prices have become excessively cheap or sell when prices have become irrationally elevated. This meets our central market criteria to “buy low, and sell high.” So, even if Elliott Wave analysis does not signal an exact turning point for when price activity has risen to an extreme (and is in need of a correction), it does help traders identify instances where contrarian positions are likely to benefit. Here we will look at some of the basic patterns that make of the core of the Elliott approach, and then outline the rules for completion that take some of the “subjectivity” out of the equation. Motive Waves The driving price movements that define the markets broader trend are called Motive Waves. Here, you can think of these price moves as the “locomotive” that drives that larger trend. In Elliott Wave analysis, Motive Waves occur in groups of five, and these groupings are always labeled 1-2-3-4-5 on Elliott Wave charts. In the first charted example, we can see how the Motive Waves define a larger bull trend. Rules for Motive Waves: 1) Wave 1 is an Impulse or a Leading Diagonal pattern. 2) Wave 2 is a corrective pattern, but is not a Triangle. 3) Wave 2 cannot retrace more than 100% of first wave in the pattern. 4) Wave 3 is an Impulse. 5) Wave 3 extends beyond wave 2. 6) Wave 4 is the next corrective pattern. 7) Price regions in Waves 2 and 4 must be separate (no overlap). 8) Wave 5 is an Impulse or an Ending Diagonal. 9) Wave 5 is at least 70% of length of wave 4 (taking away some of the subjectivity in the analysis). 10) Wave 3 cannot be the shortest leg when relative to waves 1 and 5. The Diagonal, or Diagonal Triangle In Elliot Wave analysis, the Diagonal goes by a few different names and can be divided into Leading Diagonals (LDs) and Ending Diagonals (EDs). Diagonals are 5-wave move patterns (always labeled in 1-2-3-4-5 fashion) that are relatively common, and move in conjunction with the broader trend. As we can see from the next charted example, Diagonals operate inside two tightening channel lines (think wedge formation) that are drawn using waves 1 and 3, and waves 2 and 4. The internal structure of Leading and Ending Diagonals differs however, with Ending Diagonals being the much more common structure of the two. Figure 2 is an example of a Bullish Diagonal. Rules for Diagonals: 1) Diagonals function inside two converging channel lines 2) Channel lines contract, with similar directional slopes (either bullish or bearish), and will never be horizontal. 3) Wave 1 of a Leading Diagonal can be viewed as an Impulse Move 4) Wave 1 of an Ending Diagonal forms a Zigzag (and can be a double or even triple Zigzag) 5) Wave 2 is a corrective pattern (but not a Triangle). 6) Prices in Wave 2 never exceed Wave 1. 7) Wave 3 of a Leading Diagonal is an Impulse Move. 8) Wave 3 of an Ending Diagonal is a Zigzag (and can be a double or even triple Zigzag) 9) Prices in Wave 3 always exceed those seen in Wave 2. 10) Wave 4 is a corrective pattern. 11) Waves 2 and 4 overlap. 12) Wave 5 of an Ending Diagonal is a Zigzag (and can be a double of even triple Zigzag). 13) Wave 5 of a Leading Diagonal can be an Impulse Move or Ending Diagonal. 14) Price length in Wave 3 exceeds that of both Waves 1 and 5 15) Price length in Wave 5 must exceed 50% of Wave 4. 16) Price extension in Wave 5 cannot be longest relative to Wave 1 and Wave 3. 17) Price length in Wave 5 cannot exceed that of Wave 3. Corrective Waves (Moves that Oppose the Larger Trend) The idea behind Corrective Waves is that they literally “correct” the extreme price activity that is seen during trends, and puts market valuations closer to their short, medium, and long term averages. In Elliott Wave analysis, corrective wave patterns can unfold in three or five waves, and are labeled with letters (A-B-C). Since we are looking for prices to “correct” and move toward their historical averages, these Waves will work in a direction that OPPOSES the dominant trend. Within the “corrective wave,” the term Zigzag is also applied with regularity. Zigzags are structures that unfold in three legs and are labeled A-B-C. Zigzags move counter to the broad trend and are one of the most commonly found patterns in Elliott Wave analysis. Figure 3 shows a corrective move (the colored section) which follows the major trend move. Rules for Corrective Waves: 1) Wave A will be either a simple Impulsive more or a Leading Diagonal. 2) Wave B is a corrective pattern. 3) Price length in Wave B is shorter than Wave A. 4) Wave C is an Impulsive Move or an Ending Diagonal. 5) Price length in Wave C measures at least 70% of Wave B. Double ZigZags, Triple Zigzags Double ZigZags and Triple Zigzags (sometimes abbreviated as DZ or TZ) have all the regular characteristics of regular Zigzags, except that they represent two or three Zigzag patterns strung together. These multiple Zigzags are connected by another wave (called the X Wave). Zigzags are corrective, by nature, but it is still relatively rare to see a triple Zigzag because price usually does not take this long to correct. Remember, prices could simply flatline and this would still qualify as reverting to the mean (because the mean catches up to the price, rather than the other way around). In some cases, Zigzags, Double Zigzags and Triple Zigzags might be referred to as Sharp patterns, or Zigzag family patterns. Labeling in Double Zigzag patterns is done using w-x-y terminology, and Triple Zigzags are labeled as w-x-y-xx-z. Figure four shows a double Zigzag in both bull and bear directions. Rules for Zigzag Patterns: 1) Wave W is a Zigzag. 2) Wave X is a correction but cannot be an Expanding Triangle. 3) The length of the price move in Wave X is less than that of wave W. 4) Wave Y is a Zigzag. 5) The length of the price move in Wave Y is greater than or equal to that of Wave X. 6) Wave XX is a correction but cannot be an Expanding Triangle. 7) The length of the price move in Wave XX is smaller than that of wave Y. 8) Wave Z is a Zigzag. 9) The length of the price move in Wave Z is greater than or equal to that of Wave XX. Conclusion: Understand the Structural Rules of all Price Patterns before Establishing Positions Using Elliott Wave Analysis Many new traders attempt to establish Elliott Wave trades using the often-discussed parameters of five trending waves along with three corrective waves. While this does outline Elliott’s main assertions, there are many specific details that can separate correct analysis from a mistake that is highly likely to result in losses. Here, we look at the specific parameters of some of the most basic patterns – all of which are essential for conducting proper Elliott Wave analysis. Come of these patterns are more common than others, but it is important to have an understanding of all examples, as there will be cases where some structures invalidate others. In part 2 of this article, we will cover the remaining patterns necessary for understanding proper Elliott Wave methods.

Trading with Divergences Since most practitioners of technical analysis plot indicators and oscillators on their charts, it makes sense to have an understanding of the instances where prices diverge from the signals these technical tools are sending. Most indicator tools will generate trading signals in three different reforms: signal line crossovers, center line crossovers, and in price divergences. Divergence signals are the most complicated of the three, and occur when prices and the indicator are moving in opposing directions. Bearish divergences are seen when prices are trending upward but the indicator -- such as the Relative Strength Index (RSI), Rate of Change (ROC), or the Moving Average Convergence (MACD) -- is falling. This essentially indicates that the uptrend is losing momentum and further gains are unlikely to sustain themselves. In contrast, Bullish divergences are seen when prices are in a downtrend and the indicator begins moving higher. This is a signal which suggests that traders in sell positions should exit before prices reverse higher. For these reasons, divergences should be thought of as reversal signals, and one of the greatest benefits of trading these occurrences is that they allow you to buy at cheap prices (in the midst of downtrends) and sell at expensive prices (when prices are still trending upwards). Criteria for Bullish Divergences It should be remembered that divergences can occur over long time frames, so it makes sense to look for additional signals (such as a trendline break, or a violation of support or resistance levels) in order to help confirm the reversal. In the first chart example, we can see a classic bullish divergence, where prices have posted consistent lower lows. This downtrend, however, is not supported by the indicator reading, as it moves upward and posts higher lows in the process. For trades, this information can be used in one of two ways. First, for traders that are already long, it would make sense to close the position and take profits (as there is now evidence that the uptrend is ready to stall). For those looking to enter into contrarian positions, long trades can be taken once the downtrend line that defined the previous decline in broken, or when resistance levels on short term time frames are invalidated. Criteria for Bearish Divergences In the second charted example, we see an arrangement that is indicative of a downside reversal, the classic Bearish divergence. Here, we can see a general uptrend, with prices posting a clear series of higher highs. For those using a breakout strategy, it might have been easy to get sucked into entering into long positions at the upper levels. But if that breakout trader paid attention to the activity seen in the indicator, caution would have been warranted and potential losses could have been avoided. Specifically, the indicator reading can be seen posting lower highs, are prices are reaching new peaks. Traders already long should have booked profits at this stage, as this is now a clear indication that the uptrend has run its course and is vulnerable to corrective downside reversals. For those looking to employ contrarian strategies, this contrast between price behavior and the more objective indicator reading means that a sell signal is in place. This signal is confirmed once short term support levels or broken or when prices fall below the previously established uptrend line. This would suggest that lower lows are now in place, the bull move has reached its end, and that the climate is right for new sell positions. The main benefit of these trades (especially when compared to trend trading or breakout strategies) is the fact that you would be able to short the currency pair when prices are trading well above their recent historical averages. This essentially means that there is much more downside risk than upside potential and taking trades in these areas tend to have a higher probability for success when compared to breakout strategies. Stop Losses and Profit Targets When taking trades based on divergences, the placement of stop losses is a relatively simple process. Since a buy or sell position is based on the assumption that the previous trend is reversing, all you will need to do is place your stop loss in an area that invalidates the pattern. For example, if you are trading a bearish divergence, simply find the highest peak in the previous uptrend and place your stop at least ten pips above it. The reasoning here is that if prices were to hit your stop loss area, the prior uptrend was really not over and the divergence condition seen in the indicator was not an accurate reflection of the underlying momentum seen in the market. Stop loss logic for bullish divergences is relatively similar, only in reverse. In these cases you will want to place your stop below the lowest trough that marked the previous downtrend. For profit target levels, we need strategies that are a bit more in depth because we cannot simply look at the old highs and lows from the previous trend. Alternatively, it makes sense to look at the prior trend and draw Fibonacci retracements that are measured from those moves. For example, once you have spotted a confirmed bullish divergence and taken a long position on the anticipated reversal, measure your Fibonacci levels on that move and set your profit targets at the 61.8% Fib retracement, as explained here. In the case of a bullish divergence, the 61.8% Fib retracement of the prior downtrend will likely act as strong resistance that could prevent further gains. More conservative traders could use the 38.2% Fib retracement of the same move and take partial profits (and then move stops to break even). For bearish divergences, the same levels could be used, as the 61.8% retracement is likely to act as strong support and prevent further losses. Failed Divergences Of course, no technical strategy is foolproof and it is important to look for possible reasons the divergence is failing once positions are taken. This will enable you to close the position before large losses are seen. If for example, the indicator reading re-adjusts and shows agreement with the prior trend (after the divergence is spotted), the position can be closed as the original rationale behind the trade is no longer valid. In other cases, it is important to watch critical support and resistance levels. If you spot a bullish divergence, take a long trade and then see that prices have fallen to new lows, it no longer makes sense to hold onto the short position. This is because your reasoning behind the trade was based on the assumption that the initial downtrend was over. If prices fall to new lows, you will know that this is not actually the case and that you should not be in the position. The same strategies hold true for bearish divergence, only in these cases you will be looking for instances where prices are hitting new highs. This would indicate the initial uptrend is still valid and that the majority of the market’s momentum would make short positions excessively risky. Conclusion: Disagreeing Price and Indicator Readings Suggest Reversals are Imminent Trading Divergences can be useful both for those looking to establish new positions or close existing positions once a major trend has run its course. Under ideal trading conditions both indicator readings and price behavior will unfold in perfect agreement. But, when this is not the case (and divergences are seen), warning signals should flash on the possibility of a major reversal. The most accurate divergences are seen in conjunction with other signals (such as a trendline break, a move past support or resistance or an accompanying price pattern).