Having completed the market analysis a trader must know whether he will go short or long. Besides by this time he must decide what part of his assets he should invest in the transaction. And finally the last step is buying or selling a contract. This is the most difficult part of the whole process of trading in the marginal markets where it is extremely important to define as precisely as possible the specific moment of opening or closing a position. The final decision concerning where and how to enter the market must be based on a combination of technical factors, asset management principles and the type of the market order.
The peculiarity of defining the precise moment to enter and exit the market on the basis of technical analysis lies in a very short-term nature of this analysis and is determined by days, hours and even minutes and not by weeks or months. But in all cases the same technical instruments are used. Below the most general cases of such an analysis are considered.
Strategy for price breaks
There are three ways how a trader can act in the situation of price breaks:
- - to open a position in advance forestalling a break;
- - open a position at the moment of a break;
- - to wait for the inevitable retracement after a break.
There are arguments for and against each of the three approaches. When a trader works with several lots he can open a position at each of the three stages. One can open a small position before the supposed break, then buy more right after the break and at last open additional positions during insignificant decline of prices in the course of a correction following the break. If a trader is trading small positions his decision will be influenced by two arguments:
- what assets he is ready to risk with in this transaction;
- how aggressively he will act.
The most conservative trader in such a situation will open a long position on price retracement. But paradoxical though it may seem awaiting strategy may prove to be risky as well — as awaiting for the retracement one can miss the moment of entering the market.
Crossing of trendlines
This signal allows entering or exiting the market rather early especially when a crossing of a significant tested for many times trendline occurs. Of course one mustn’t forget about other technical indicators as well.
In case trendlines are used as support and resistance levels long positions are opened when prices decline to the level of a stable up trendline, while short positions are opened when prices rise to the level of the down trendline.
Usage of support and resistance levels
A break through the resistance level may serve as an indicator to open a long position which can be protected then by means of a stop-order. It may be placed under the nearest support level or for more safety right under the level of the break which now will serve as a support.
The price rise to the resistance level during the downward trend and the price decline to the support level during the upward trend may be used for opening new positions and for adding lots to profitable positions that we already have. When choosing levels of protective stop order first of all one should pay attention to the resistance or support levels.
Usage of price corrections
During an upward trend interim price declines constituting percentages of the previous rise according to Fibonacci may be used for opening new or additional long positions. It should be mentioned that in this case analysis of percentages of the length of a correction refers to very short periods of the market movement.
An appropriate moment to open a long position is a 38 -percent price retracement which occurs usually after a bullish break during the upward trend. It is rather reasonable to open short positions when during the downward trend prices bounce up covering 38 to 62 percents of the previous decline.
Usage of gaps
Price gaps forming on the bar charts also may be used for choosing an optimal moment to open or close positions. For example gaps forming in the process of price rise often serve later as support levels. That’s why during an upward trend it is reasonable to open long positions when prices decline to the upper border of the gap or a bit lower into the gap. A stop order may be placed under the gap. During a downward trend a short position is opened at the moment when prices rise to the lower border of the gap or even fill it in partially. A stop order in this case is placed above the gap.
Averaging
Averaging it is a strategy when you made a mistake or simply made a transaction (the first one that came to your mind),and price went against you and you make a transaction of the same type but at a more profitable price. The main disadvantage of averaging is the fact that you don’t know in advance to what price the market will move against you. And averaging requires investing each time (after the first one) a doubled of the previous sum of margin. But if you have a lot of money you can allow a price movement in 100, 200 and more pips. Though such movements in the market occur rarely – this is not the best strategy especially if you see that you defined the direction of the trend erroneously.
Possible strategies
- The first strategy lies in keeping positions open for a long time (from several days to several months). Such a strategy is used by strategic investors and semiprofessional speculators. It is profitable at most during newly emerging trends and it is least profitable during sideways or sluggish trends. It requires securing and corresponding work in the options terminal market. When a trader works on long positions fundamental analysis is as important as technical analysis. The proportion of long positions in a trader’s practical work mustn’t exceed 15% of the margin. Also analysis for opening long positions will help you when you go short, namely:
- a) to determine long-term resistance and support levels;
- b) a strong long trend will warn you when you work against it on short positions;
- c) you will have a psychological confidence when you work on a short position in the direction of a long trend.
- The second strategy lies in working on intermediate-term trends which last up to several days. In this case securing by means of options is also desirable. It is most attractive for nonprofessionals. Intermediate-term positions are more stable for getting profit though analysis for taking decisions in such a strategy is a bit more complicated. In this case the quality of work depends also on ability to choose the correct moment for opening and closing positions. When opening ntermediate-term positions it is necessary not only to make a technical analysis but to monitor carefully releases of economic news of fundamental nature before closing a position. The psychological factor is relegated to the background. In spite of external stability of this tactic it is highly recommended to monitor the market carefully as it is unpredictable. If you choose the intermediate-term strategy based on fundamental factors you should also ensure that technical analysis doesn’t at least contradict your positions.
- The third strategy lies in opening short-term positions from several minutes to several hours in duration. Advantages: there is no risk of appearing unfavorable fundamental news and price changes at the moment of your absence. Disadvantages: considerable expenses (commissions, spread, communication services etc.), big risk of unfavorable short-term price changes, it requires constant monitoring, concentration and exertion during the whole working day. The main assistant when you work using this strategy will be oscillatory methods of technical analysis (use the rules of choosing entry moments). Do not flatter yourself with a small profit received using this tactic. You may lose very quickly everything you have been earning for so long and having made so many transactions.
The most appropriate for an unprepared trader is the second strategy (trading on intermediate-term trends up to several days in duration).
In our text-book tens of technical indicators are described, but it is impossible to use concurrently more than 3-4 indicators to analyze the current situation in the market. Otherwise analysis will take a long time and by the moment of its completion its results will be dated.
A logical question now arises — which indicators should be chosen from the great variety?
Unfortunately there is no unambiguous answer to this question. The point is that the success of trading depends not on the set of indicators you use for analysis but on its methodology.
The whole trading is based on four pillars.
1. Understanding of the philosophy of analysis.
Andrey Vedikhin, Deputy Director General of Alpari: «Technical indicators on weekly, daily, four-hourly and hourly charts of the Japanese yen showed explicit signals to sell. The «situation» couldn’t be clearer even in books that’s why I decided to make my first transaction on a live account and … a Loss
Belief in technical analysis was irrevocably lost. A wish to trade foreign currencies disappeared. Fear appeared in return. Fortunately a wish to think didn’t disappear that’s why rather quickly I made a conclusion that it was a mistake to delegate the book on technical analysis to the furthest drawer of the desk. The events came absolutely logically. The weekly and daily charts spoke for existing of a global down trend while the four-hourly and hourly charts showed the trend movement was on the way and apparently had reached its bottom.
An ideal moment for selling would have been a situation when large charts had indicated exisiting of global bear trend while the four-hourly chart had indicated bull trend while on the hourly chart reversal patterns of up trend (e. g. bullish divergence) had been noticeable.
Thus don’t hurry to blame in an unsuccessful trade the authors of books who gave some recommendations on methods of analysis but try at first to understand and feel the philosophy of analysis. It will help you to find the reason of your mistakes in trading and to avoid them in the future.«
2. For a successful work it is necessary to know:
- Market analysis. I.e. to know how to forecast price dynamics in the future. The type of analysis (technical analysis, Chaos theory, Japanese candlestick combination, Demark’s theory, the Ichimoku indicator and etc.) doesn’t matter, the main thing is to know how to use it professionally.
- Trading strategies. I.e. to know how to choose the proper moment for opening/closing a position (it will be considered in detail in the following articles).
- Money management. I.e. to know how to limit risks (it will be considered in detail in the following articles).
- Psychology. I.e. to avoid emotional decisions (it will be considered in detail in the following articles).
3. Support-resistance levels.
The main rule of a trader: to buy from support levels, to sell — from resistance levels. If your trading strategy shows it is time to buy but price hasn’t reached the support level don’t hurry with opening a position.
4. The correct choice of periods of analyzed charts.
In consequence of trading in the FOREX market for several months You will understand that in the currency quotations there is some«noise» (in about 10 pips). The reasons of this«noise» may be different: a big order in the interbank market, imperfection of the indicative quotations source and etc. In any case you should accept the fact of noise«existence»in currency quotations as an axiom.
Then:
- analysis of minute charts will allow to catch a movement in 15 pips (from them 10 pips will constitute«noise», i.e. 66);
- analysis of a 5-minute chart will allow to catch a movement in 30 pips («noise» 33);
- …
- analysis of hourly charts will allow to catch a movement in 100 pips («noise» 10);
- analysis of daily charts will allow to catch 500 pips («noise» 2).
Depending on volatility of a currency pair particular numbers may be different but the principle remains invariable:
When a trader analyzes short periods he tries to forecast «noise», while when he analyzes long periods he tries to forecast the market. «Noise» is unpredictable due to its randomness. The market — is predictable. That’s why if you don’t want to rely on randomness in defining the future price dynamics, you will have to forget about analysis of charts of periods less than an hour. On weekly and daily charts define the main trend and on hourly charts look for a moment to enter the market.
