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Tried, tested and simple rules can reap the short to
medium-term trader a profitable harvest in the rich
pastures of the money markets. Shares chartist David
Jones looks at the opportunities
When it comes to trading strategies
for FX markets, it does not have to
be a case of reinventing the wheel.
Like all markets such as shares,
indices, commodities - they go up, they go
down, and they go sideways. The difficult bit
is of course figuring out where they are going
next and positioning yourself accordingly.
Currencies are the biggest market in terms
of daily volume. This makes them very liquid
and a great proposition for short to mediumterm
trading. Simple techniques that
investors and traders use in other markets can
transfer easily to the various currency pairs. As
an analysis approach, technical analysis and
charting is probably more widespread in
currencies than any other market.
Historically currencies have been a shorttermers
market and, without news happening
every minute to drive these markets, it boils
down to good old supply and demand - a
battle between the bulls and the bears.
Because technical analysis is not so much
about squiggly lines and crystal balls, but
more mass-market psychology, where better
to apply it than the biggest market place in
the world?
Trends and support and resistance
The approach used does not have to be rocket
science either. The old chartist stalwarts of
trend following, support and resistance are
very effective in FX, across all sorts of time
frames.
First, currencies do tend to trend well. The
past two-and-a-half years have seen the euro
rise by around 50% against the dollar - a 4,000
point move. The past six weeks have seen
another strong trend for euro/dollar
(EUR/USD) - a near-1,000-point move. Both
these trends have been the classic progression
of higher highs and higher lows and there
have been plenty of opportunities to jump on
board.
Because trends in currencies can be
substantial, not trading against the trend
should be consideration number one. You
may think there is no way the pound/dollar
exchange rate (GBP/USD) should be as high as
1.8600, but the market is bigger than you are so
it would be financially dangerous to stand in
the way of a strong trend. Far easier to go with
the flow and ride these trends for as long as
possible - which brings us to support and
resistance.
The principle of support and resistance is
much covered when it comes to technical
analysis - and takes about five minutes to
understand and start applying. Unfortunately
some people seem to shy away from this
approach because it is too simple and not sexy
enough - more fool them because it works,
and it works particularly well in FX.
The pound and the dollar - support
The idea behind support and resistance makes
perfect sense - levels that were important in
the past should be important in the future. So,
if GBP/USD for example slid to 1.7700 then
bounced back up, the assumption is that any
weakness back to the 1.7700 area should bring
the buyers back in again. This could be used as
a set-up for buying GBP/USD - which was the
case in September and October.
On 5 September,
GBP/USD traded down
to 1.7706, as can be
seen on the chart.
Based on this chart
there was no way of
knowing it would
bounce from here, but
it managed to rally
around 300 points over
a few days.
At this point it is
clear 1.7700 is reasonable support - sentiment
changed at this point and the buyers stepped
in - causing the pound to strengthen and the
dollar to weaken. On 13 September, GBP/USD
slid heavily, but only down to 1.7738 before
bouncing again. The chart watcher who was
looking for an area to buy into GBP/USD
would have seen this as an opportunity - the
expectation is that 1.7700 will continue to
provide a floor under the market.
But let's say our eyes had been off the ball
and we missed the trade. At the end of
September GBP/USD was trading above
1.8100. By now it was clear any weakness back
towards 1.7700 would be viewed as a buying
opportunity as this was support. The everconsiderate
market gave us another
opportunity to buy in on 4 October, with
GBP/USD slipping back to 1.7744. Once more,
sentiment turned, and the FX pair moved
higher.
As ever, risk management should be the
number-one consideration when it comes to
financial markets. Going back to shares for a
moment, the bear market from 2000 to 2003
should have taught people the importance of
stop losses - having a plan to get out when
things do not turn out as you thought. The
sort of investor who buys the latest hot penny
share then sticks his head in the sand for a few
months hoping it goes the right way will very
quickly find himself and his money separated
if he uses the same techniques in the currency
markets. In FX 300-point ranges week-by-week
are not exceptional, so having stop losses in
place is particularly important if you do not
want to find yourself on the wrong side of a
major move.
This again is where support comes in. If we
know that 1.7700 in the example above has
proved to be a floor for the market and we are
using that as a reason to buy, then if 1.7700 is
broken what is the point of still being in the
trade? There isn't one and all the spread
betting companies and brokers that provide
FX trading will allow you to place stop losses
to get out if sentiment changes.
The euro and the dollar - resistance
The flip side of support is resistance. This is a
level where rallies have consistently run out of
steam. For this example we will use
(EUR/USD). Earlier this year the rally ran out of
steam and from March to early October the
1.2400 to 1.2470 area capped any rallies. So, one
strategy would have been to sell short
EUR/USD when it moved up to these levels,
looking for the price to fall. But on 13 October
something changed and EUR/USD traded
through 1.2500. At this point the market is
holding up a large flashing sign saying
'something has changed'. If you were short,
this was the signal to get out. In the same way
that a break below support suggests sentiment
has changed, a break through resistance shows
the bulls are very much in control - the
expectation is for a move even higher to begin.
Breaks through these sorts of key levels can
be another strategy for trading FX. Breaks
below support are sell signals, breaks through
resistance are buy signals. Again, placing a stop
loss is all-important because this sort of
strategy is not a holy
grail that works all the
time and false breaks
do happen. One stoploss
strategy if you are
trading these sorts of
breaks is to get out of
the currency dips back
through the breakout
point by a significant
amount. Applying this
to the EUR/USD break
in November, there
was no major
retracement following
the move through
resistance and by early
November it was a
good 500 points
higher.
The importance of timing
The examples used have all been based on
daily charts and looking at significant moves
over days and weeks.
However, support and resistance works in
all sorts of time frames because all you are
doing is looking at raw market sentiment.
Friday 5 November is a good case in point.
Looking at an intra-day chart of GBP/USD
starting at the last week of October, there was
clearly lots of support in the 1.8270/1.8300 area -
but lunch time Friday saw the pound trading at
1.8450 - a good distance from this support. At
1:30, US employment numbers were announced
and were much better than expected, causing a
surge in strength for the dollar and
of course a corresponding slide in
the pound. GBP/USD slid sharply to
1.8306, just ahead of the support
zone, then snapped back up just as
quickly to end the day around
1.8550. This is a two hundred-plus
point bounce from the support
level, once again proving the worth
of this very simple strategy.
The final part of the strategy
boils down to the mechanics of
how to place the trades. Because
FX is a 24-hour market and at times
(like Friday 5 November) can be
very volatile, being in front of your
screen when your level gets hit can
be rather hit-and-miss. This is
where you get your FX company to
do the work for you.
All companies let you place 'limit' orders - to
buy at a predetermined level, if your currency
should get there. So last Friday you could have
left an order to buy at, for example, 1.8330, even
though GBP/USD was trading 100 points above
it. If it slid, your order would be filled. The vast
majority of companies let you place your stop
loss at the same time so again if things do not
work out as planned and if GBP/USD kept
sliding, you would be out at a manageable risk.
Favouring disciplined risk managers
To wrap things up, when it comes to simple
technical analysis and the range of price swings,
FX is probably the market that 'plays by the
rules' the most. But it is not a market just
sitting there to deliver easy money to
participants - belligerently holding on to a
position when the market is clearly against you
will prove expensive. However, if discipline and
sensible risk management are employed it
really is a market worthy of consideration by all
active traders and medium-term investors -
there is nothing quite like it.
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