Forex Strategies and Tips
Seeing What You Want To See
As we began our trading careers, we were initially introduced to chart patterns and found them fascinating.
Head and shoulders patterns, ascending wedges, pennants, the king's crown, triangles, flags, etc. We found that the famous M's and W's had been documented in 1971 by Robert Levy and later by Arthur Merrill in the 1980, and again by John Bollinger, and we studied them in depth. We were taught that these patterns reflect the aggregate results of market sentiment – the combined push and pull of supply and demand, the bulls and bears tug-of-war.
We went on to study Japanese candle patterns, learning that the shape of even a single candle can tell you so much about the market. Fascinating stuff. And we spent another fortune in classes and webinars learning Fibonacci patterns called gartleys, crabs, butterflies and the like. The more we studied, the more interesting it all was.
So it's no wonder that the day we read Larry Williams' book Long Term Secrets to Short Term Trading we literally stopped dead in our tracks and said "Whoa! Wait a minute! We've been duped again!"
Here's the chart he showed us:
What Does This Chart Look Like To You
It's a perfect head-and-shoulders pattern, right? We've highlighted it in green you.
Is it the EURUSD?
Is it grain or cattle or a particular stock?
No. It's the weather! - the daily highs and lows of temperature.
How arbitrary is that?!
How about this next chart which could be interpreted as perfectly showing the behavior of the reputed market makers who are manipulating the market by accumulated contracts (in yellow) followed by a vicious stop hunt (orange arrow).
What market is this? Which currency pair and time frame?
Well, this is a chart we just generated based on 150 random coin flips. Yep, heads or tails. Talk about a wake-up call!
We found an excellent Excel spreadsheet created by Timothy R. Mayes, PhD, faculty member in the Finance Department at Metropolitan State University of Denver
You can download a version of this in Excel 2007 format here, and try it for yourself. As you open the spreadsheet up, enable macros, and then you can click the Flip Coin button.
Generate several random charts and see how many patterns you can recognize from the results. Pretty amazing, isn't it?
Can you recognize gartleys or fib retracements? Can you find the 'Three pushes to a top' pattern in operation? Can you count levels or recognize Elliott Waves? Sure you can.
But do they really mean anything? Are they telling you about market psychology? Nope. They tell you about as much as the patterns you see charting a random bunch of coin tosses, or any other random behavior.
Beware Seeking the Fulfillment of your Expectations
If you can't rely on chart patterns, does that mean you can't make money trading Forex? Is that the conclusion we want you to make? Far from it.
What's going on with chart patterns is the tendency of the eye to recognize only that which works and conforms to our expectations. When you glance at a chart, your eye sees the 'head and shoulder' that goes down, but totally misses seeing the 3 other times that were starting to shape up as a head and shoulder pattern and never carried out your prediction and would have failed horribly. This is human nature and it's unavoidable. Want proof for yourself?
Here's how. If you use the Forex Tester and go candle by candle then your charts will look just like they do in real time. You won't be able to see what's coming next; there's actually blank space on the right edge, just like real life.
Do this and start looking for your trade criteria. It's the only way you can be honest with yourself and avoid seeing only the trades that work. We know you're not intentionally cheating when you look back at your broker's charts and try to read them - but you can't help the kind of unconscious cheating we all do when we look at a complete finished chart and cherry-pick our perfect pattern or see a glimpse of what's coming next on the right edge of the chart.
Because we're not selling you a strategy, and because we were registered CTA's, we're in a rare position to sit back and tell it like it is. So we wanted to share this alternate view about magic chart patterns with you. Question Everything... REALLY!
Do You Marry Your Trade?
We've had traders tell us:
"I can't trade well because as soon as I pull the trigger and enter my trade, I am married to it and can't see when I should get out or how to manage it."
When you're long a position, it's so difficult to see price action from the side of the bears. It's as though all your mind gets pulled into looking at your charts exclusively like a bull, wishing your trade to go up.
Trading Forex is all about the battle between the bulls and the bears. The two teams of Forex players, the bulls and bears, are always going after each other. The bulls want their pair to go up and the bears want their currency pair to go down.
Because two currencies are always pitted against each other, that's just not possible at the same time. Each moment has a winner and a loser.
And when you're trading Forex, you are actually both bull and bear in the same trading session. You can be loyal to the bullish team and take a trade to the long side, but the minute you close that trade for profit, guess what? You're a bear now because you've just gone short in order to get out of the trade.
Some trading platforms make this transparent because to close a trade, you have to put in an order for the same size position going the opposite direction, but most trading platforms these days disguise the mechanics of closing the trade through the simple convenience of having a CLOSE button.
Think About BOTH Sides
We think about both sides of the battle when we take a trade.
Thinking like the other team helps us to determine our entry and our exit prices.
For example, if we're in a bear trade we'll ask ourselves, where do we think the bulls are waiting to get in? Will they think that price is going to stall at a big number like 1.2000 and jump in then, or will they wait until a certain clear Fibonacci number is hit?
Many traders actually set pending orders at certain key levels, whether it be price points like whole numbers or key places in a pattern. These are commonly known as "bear traps" or "bull traps" and thinking of them in this way can really be useful to a trader.
Just like setting a trap in the wild, think of these key levels filled with orders waiting to be triggered the minute price hits them.
If you are trying to navigate a way through the Forex wilderness yourself, you'll want to look ahead and know what lies in front of you and where these traps might be located so you don't unwittingly step into them.
Use whatever imagery you can to get this concept into your thinking. The image of trekking through the wilderness is one way of remembering the interplay between both sides.
Here's another way - Instead of just looking at your charts as a technician and simply reading patterns or looking for your head and shoulders, or your pennant, or your indicator hitting a specific pivot line, do this instead: Think of Forex as a sport.
When you place a trade, you're on one side of the fight and when you pull the entry trigger, you're either buying or selling to the guy on the other team.
Watch what their reaction is. Are they staying on the sidelines and not sending in their blockers or guards? Are they letting you run with the ball? And how far will they let you run?
Know ahead of time where your specific goal line is and target that for your exit or a place to protect profit. If they send in their blockers and guards right away to keep you from gaining any yardage, think about how much you're willing to give up before bailing on the trade.
Loyalty to your own team counts for nothing in Forex. You might even want to consider jumping over to the other side if you sense that they have more power for the next move.
If you really want to master this way of thinking about trading forex, start a new discipline of making a list before entering a trade. One side of the list is the Bear side and the other is the Bull side.
For each trade, be a bull and make your list as a bull, "I see the following reasons to go long right now"…. and list your reasons. Do the same for the bear side of the trade.
You'll be surprised what you come up with as you defend each side's reasons for taking the trade. And make sure that when you do this, you're not biased for either side.
Keep Your Mind Limber
Trading forex is about being limber on your feet. Too often we get stubborn and refuse to believe that a trade will go all the way to our stop and hand us a loss.
Traders find it difficult to think like the other team and consequently they stay with the losers until the bitter end.
Being fluid and limber means that you don't mind dumping a loser and joining the other team. Thinking like both sides gives you an advantage in the game of Forex and keeps you sharp and focused on the trade as it plays out.