Forex Trading Correlations

Expert: Dan Blystone, Founder at TradersLog.com

Who is Dan Blystone?
Dan Blystone is founder of TradersLog.com - a website that focuses on technical and fundamental analysis of the financial markets, and also features a forum and chatroom.

Originally from London and now based in Chicago, Dan was previously a professional futures trader. He worked on the floor of the Chicago Mercantile Exchange in the currencies and the S&P pit, later traded Eurex's bund futures, and most recently traded the US 10 year note futures. Having also worked at ABN AMRO's interbank desk in Chicago, Dan has a keen interest in the world of forex trading and has enjoyed working with FXStreet.com over the past year.

Session Transcript

Moderator_FXstreet
Good morning, good afternoon, and good evening to all of you joining us today from different parts of the world. I want to welcome all of you to today's Live Forex Expert Question and Answers session.

Moderator_FXstreet
Welcome to FXstreet.com Q&A Forex Session. Today s session will start in 5 minutes.

Moderator_FXstreet
Welcome to the Session. Today I am delighted to welcome our guest speaker Dan Blystone, Founder at TradersLog.com.

Dan_Blystone
Welcome to todays sessions everyone, and thank you for joining us. We'll get started in a couple of minutes!

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Right, lets get started. Today we'll be discussing some technical trading strategies for the forex market.

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We'll begin with a look at Japanese Candlesticks.

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In the 1700s a Japanese man named Homma, a trader in the futures market, developed a method of technical analysis to analyze the price of rice contracts known as candlestick charting.

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Candlestick charts display the high, low, open, and close for a security each day over a specified period of time, in a format similar to a bar chart, but in a manner that extenuates the relationship between the opening and closing prices.

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A narrow line (shadow or wick) shows the day's price range. A wider body marks the area between the open and the close, referred to as real body.

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If the close is above the open, the body is white or green (not filled); if the close is below the open, the body is black or red (filled).

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Steve Nison is credited with popularizing candlestick charting in the west and is seen as a leading expert on their interpretation.

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lets take a look at a classic candlestick formation

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this one is called 'the hammer'

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On a Japanese Candlestick chart, the hammer is known as a reversal candlestick.

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Hammer candlesticks occur when a security moves significantly lower after the open, but rebounds to close well above the intraday low.

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In a perfect hammer, this tail is twice the length of the body and the candlestick will have no upper shadow or wick.

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The smaller the body and the longer the tail, the more significant the hammer is as a bullish indicator. Hammers form at trend bottoms. If this candlestick forms during an advance, it is called a Hanging Man.

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you can see what it would look like on a chart here: http://www.traderslog.com/Hammer.htm

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there is also more info on classic candlestick set ups here:

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http://www.traderslog.com/Japanese-Candlesticks.htm

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lets now move on to discuss some different trading strategies

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The Big Picture

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A very important factor in having an edge in the market is to be aware of the big picture - identifying the type of market that exists, whether it is trending or range bound.

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To grasp this it is essential to use multiple time frame analysis - even if you are a day trader, you should be looking at daily, hourly and 10 or 15 minute charts. The longer term charts will give you an idea of the overall temperament of the market.

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One of the foremost strategies used by banks and hedge funds is to determine the overall trend of the market and enter trades at key retracement levels of that trend.

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One of the advantages of trading the forex market is that it normally trends more than the equities market, due to the fact that macroeconomic events can continue to influence the market over a timeframe of months and years.

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The fx trader should expoit this understanding of the overall trend of the market by positioning themselves in the direction of the trend.

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In an uptrending market, look to buy pullbacks at key levels and the inverse for a downtrending market. One of the strengths of the fx market is that you can expoit market moves whether they are to the upside or downside.

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Identifying good entry points to join the trend

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A variety of technical tools are used to help gauge good entry points. Basic support and resistance levels (characterised on a bar chart by a sequence of lows or highs that fluctuate only slightly along a horizontal line and represent a level where buy orders outnumber sell orders or the inverse) on a daily chart and fibonacci levels are two examples.

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I recommend taking a look at Martin Prings article on how to identify support and resistance levels:

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http://www.traderslog.com/support-resistance.htm

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Lets take a quick look at Fibonaccci Levels:

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Fibonacci levels are created by drawing a trendline between two extreme points and then dividing the vertical distance by the key Fibonacci ratios of 23.6%, 38.2%, 50%, 61.8% and 100%.

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I have found the 38 and 50% levels to be the most significant. The fib levels were a popular form of analysis among the interbank traders I worked with, and I found the 38% level to work with an eerie accuracy on the 30 minute chart while trading bund futures. Again the longer the timeframe used, the more significant the level.

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Measuring the strength of the trend

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Attempting to buy the low and sell the high is very often the undoing of the inexperienced trader - and while this strategy works in a range bound market, it is best avoided unless you have identified a market as such.

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An important tool for determining the strength of a trend and whether a market is range bound is the Average Directional Index or ADX.

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Measured on a scale between 0 and 100, readings below 20 are used to indicate a weak trend, while readings over 40 indicate a strong trend. ADX is not used to show the direction of a particular trend, rather to measure its strength.

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Stay away from trend following trades if the ADX is below 20 and trending downward.

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US Dollar Index

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The US Dollar Index (USDX) is a futures contract offered by the New York Board of Trade. It is a trade-weighted average of six foreign currencies against the dollar. Currently, the index includes euros (EUR), Japanese yen (JPY), British pounds (GBP), Canadian dollars (CAD), Swedish kronas (SEK) and Swiss francs (CHF).

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USDX broadly reflects the dollar's standing compared to the other major currencies of the world. It is widely used to hedge risk in the currency markets or to take a position in the US Dollar without having the risk exposure of a single currency pair.

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The US Dollar Index allows the fx trader a feel for what is going on in the FX market globally at a glance. If the Dollar Index is trending lower, then it is likely that a major currency that is a component of it is trading higher.

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Important Psychological Levels

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We're seeing alot of important psychological levels right now in the market - with the GBP/USD especially!

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The British pound broke through the $2 mark for the first time in nearly 15 years after new data showed an unexpected surge in inflation, prompting speculation of interest rate increases.

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FX day traders should be able to identify price areas where large order flows will be triggered through the interbank market, and take advantage of the moves that are created by them.

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Such levels include major areas of support and resistance on the daily chart and also round numbers such as double zeros - for example EUR/USD 1.2700.

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Careful placement of stop loss and profit target orders enables the trader to execute trades with a strongly positive risk/reward factor.

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For example, one might place a stop loss of 15 pips from the level and a profit target of 50 pips on the other side if you are attempting to profit from a bounce at such a level.

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One should note that stop loss orders are normally placed somewhat beyond the key round figure numbers and profit taking orders are normally right at the key levels.

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Attempting to catch a rebound off a major level is best executed when there are other technical factors supporting the rebound. For example if the market had been trading below its 20 period Simple Moving Average (SMA) prior to reaching the key level, this would support the decision to attempt to catch a rebound at that level.

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Identifying these key levels can provide good entries to trades where you are joining the trend, as we discussed earlier, or if you are attempting to profit from a rebound off such a major level.

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Bollinger Band Strategies

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Bollinger Bands are a popular study used across all markets - including fx.

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They can be useful in both generating entry and exit signals and gauging trends. The basic interpretation of Bollinger Bands is that market prices will tend to stay within the upper and lower bands.

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Bollinger observed the following characteristics of his indicator: - Sharper price movements tend to occur when the bands tighten and volatility decreases. - When prices move outside the bands suggests a continuation in the direction of the overall trend. - Bottoms and tops made outside the bands followed by bottoms and tops made inside the bands indicates a trend reversal. Bollinger Bands are best used along with other indicators, such as an oscillator like the MACD.

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Pivot Point Strategies

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An old but reliable tool, originally used by floor traders are pivot points. They are another valuable tool for determining key support and resistance levels.

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The prices used to calculate the pivot point are the previous period's high, low and closing prices. These prices are usually taken from the currency pair's daily charts, but the pivot point can also be calculated using information from hourly charts. Normally the pivot points are taken from a daily chart and applied to intraday trading.

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When the market opens above the pivot, the bias for the day is on the long side. An open below it suggests a bearish bias.

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Typically the trading range is confined between the first support and resistance levels and these along with the pivot itself are the most important areas for you to consider.

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While looking at pivot points you should be looking for a reversal or break through of the support and resitance levels. If the level fails to hold, this suggests follow through, and the second level of support and resistance can be used as a target.

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Interestingly, an area that was a strong support level can often become a resistance level once it has been violated and retraces back to that same level (and the inverse for a previously strong resistance level).

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Again, these levels are best used when confirmed with other technical indicators.

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Finally, lets take a look at Inside Day Breakouts

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An 'inside day' is one where trading is contained within the trading range of the previous day.

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The volatility breakout strategy entails entering a trade on a stop order above or below the range that has been previously trading - with the expectation that since a breakout has occured price will continue to move in that direction.

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Volatility breakout systems are based on idea that if the market moves a certain percentage from a previous price level, the market is likely to see follow through in that direction. In this scenario you are looking for a continuation of the move based on momentum.

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One should look for a series of inside days to implement this strategy, and the greater the number of inside days that transpire, the higher the probability of a breakout.

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Also, the longer the timeframe used, the stronger the breakout opportunity - hourly and daily timeframes are the best to use.

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This strategy is also best used with pairs that see tighter ranges - these are typically the crosses - currency pairs that do not have the USD as part of the pairing such as the EUR/GBP and the EUR/CHF.

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Inevitably there will be false breakouts, as the interbank dealers try to trigger the stop orders just outside the breakout levels.

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In order to avoid being caught in a false breakout situation, enter your trade with a stop order at least 10-15 pips above the breakout level - meaning the levels above or below the trading range depending on whether the market is breaking out to the upside or downside.

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(In case you are not clear on this - a stop order is one that is placed above or below where the market is currently trading and becomes a market order when the market touches the price where the stop was entered. A buy stop is placed above the market and a sell stop is placed below.)

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Again - one can look to the ADX as an indicator to whether the market is still range bound or beginning to trend one way or another.

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Stay away from inside day breakout trade if the ADX is below 20 and trending downward.

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The breakout strategy is valuable in that it teaches the trader to do something that is normally counter intuitive - that is to buy the high or sell the low. Novice traders are more likely to try to pick tops and bottoms.

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Often the breakout will occur in a fast moving market, making decisiveness even harder. However, if your strategy is in place and you have identified the opportunity, you will be ahead of the game.

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now lets move on to the q&a part of our session!

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please feel free to submit your questions : )

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can't believe this gbp/usd

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great time to be trading fx

Okietrader
<Q>FXWords.com shows different candlestick patterns for FX and Equities. This was the first time I had seen/heard of that. What is your opinion...can the patterns be interpreted the same for both instruments, or not?

Dan_Blystone
<A>Hi Okietrader - yes the patterns apply the same for both fx and equities - and all technical analysis (bollinger, macd) apply in the same way to fx as they do to other markets

ber
<Q>parabolic sar???????

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<A>Hello ber - Introduced by Welles Wilder in his 1978 book, New Concepts in Technical Trading Systems, the Parabolic SAR (PSAR) is an indicator that sets trailing price stops for long or short positions. It is more popular for setting stops than for establishing direction or trend. More: http://www.traderslog.com/parabolic-sar.htm

nick_s
<Q>I trade the 15min chart primarily, when using ADX what period and timeframe do you recommend to help determine the current market condition? should a higher timeframe be used?

Dan_Blystone
<A>Hi Nick - yes, by all means look at the longer time frame when using the ADX - remember the fx market is one that is particularly susceptible to trends over long time periods - so this will help you get the 'big picture'

Beforex
<Q>Do you think the gbp/usd will stay above 2 or will there be a retracement?

Dan_Blystone
<A>I think there's a great opportunity here - I honestly want to be short gbp/usd - I think it will return to below 2 - but there may well be alot more upside - most importantly, don't overleverage yourself!

gastonmckenzie
<Q>Are all these tools only specific to the forex market

Dan_Blystone
<A>not at all - technical analysis applies to fx in the same way that it applies to stocks, futures etc.

Guest_RSI_14
<Q>Re hammer/hanging Man , U have said it is good reversal pattern , and as far as iam concern it signifies weakening market sentiment, how ti identify when this formation occure in a downtrend or up trend, can i consider that if such formation occure in a downtrend is a bullish signal and bearish it an uptrend ,

Dan_Blystone
<A>its always good to look for confirmation from other indicators - so when you have a candlestick pattern suggesting a reversal you might look also to the ADX for confirmation

nick_s
<Q>dan how do you handle trading as far as establishing a routine goes? obviously its not possible for some of us to trade the 2 or 3 major sessions. hope this is within the scope of this q&a. thanks.

Dan_Blystone
<A>with a 24 hour market 5 days a week its hard to have a normal routine! For day trading I like to trade when there is most volatility so I look to the european and us openings - for swing trading I try to keep an eye on the market as much as possible at all times!

Guest_RSI_14
<Q>gbpusd , i believe it is not an ideal entry to short the siad pair after such an uptrend, any good?

Dan_Blystone
<A>you are right in thinking that it's a bad idea to fight a trend! My thoughts are simply that eventually the gbp/usd must return below 2 - the question is when and it might be a long time

gastonmckenzie
<Q>How does one decide which array of tools to use. Surley it can get very contradictory and confusing

Dan_Blystone
<A>I would suggests testing maybe a dozen or so indicators for the markets you are trading and see which ones work best - then narrow it down to 3-5 indicators- I agree, if you have too many it gets confusing and counterproductive!

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before I go, I would like to encourage you to check out the commentary on our forum, we have a wealth of fx analysis there: http://www.traderslog.com/forum/

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its a good idea to browse through the analysts commentary each morning to gain some perspective

gihondragon
<Q>Thanks so much for this wonderful explanation of various means of interpreting the market, but I thought this webinar was supposed to be about Candlestick interpretation?

Dan_Blystone
<A>Hi gihondragon - I'm planning to go into greater depth with the candlesticks in my next presentation - so I hope you'll join me there!

gihondragon
<Q>Thanks so much for this wonderful explanation of various means of interpreting the market, but I thought this webinar was supposed to be about Candlestick interpretation?

Dan_Blystone
<A>covering the candlesticks is better suited to the webinar format, where we can go over charts together and you have the visual element of the presentation

nick_s
<Q>great thanks dan! very much appreciated.

Dan_Blystone
<A>you're very welcome - hope to see you at the next presentation and that you'll profit from the great volatility we are seeing in the market!

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I have to wrap it up here - thank you all for coming and see you next time : )

Moderator_FXstreet
Thats all we have time for Today .Thank you very much for that dAN.

Moderator_FXstreet
Thank you all for your participation. See you soon!