Ascending and Descending Triangles in Forex Trading

Forex traders say that “the trend is your friend” in the currency market. In other words, they try to ride a trend for as long as possible, buying dips in bullish ones and selling spikes in bearish trends.

The problem with this approach is that the market doesn’t trend that much. It depends very much on the currency pair and the period considered.

Of course, any EURUSD trader that was bullish this 2017 will argue that the pair was in a stable trend for most of the year. It rose from 1.05 to over 1.20 in less than six months, in an almost vertical line.EURUSD.iDailyThe problem is that the market doesn’t form such trends often. Moreover, even during trends so strong, it takes time to consolidate, to build energy before breaking, higher in this case.

Rookie traders will argue that this is the easiest trend to trade. Simply stay long until the channel breaks.

I tend to argue with them. Because the enemy to a trading account is the trader him/herself, staying long on this time frame (daily) isn’t easy.

Traders face a tough decision in the fear/greed play: to close the position/positions before the weekend or to keep them open.

Ascending and Descending Triangles

To be more exact, this bullish trend took over 130 days. During this time, there were a few weeks where the intraday/intraweek price action was extremely bearish. That’s where the trend consolidates and when triangles form.

If the triangle breaks in the same direction with the underlying trend, it is called an ascending triangle (in a bullish trend) or a descending one (in a bearish one). Effectively, the price builds energy to break in the same direction.

Let’s zoom in the previous EURUSD chart:

eurusd chart

We see that for over twenty-three (23!) days, the price didn’t do anything. It merely consolidated on the horizontal.

You can say what you want, but the truth is that the psychological factor in trading will see many of retail traders closing the previous long trades, booking the profits, and most of them even going short for whatever reasons.

If you add the fact that the EURUSD has a negative swap for trades kept open overnight, few retail traders bear to pay that small interest on a trade, for almost a full month.

Yet, the market formed a classic ascending triangle: a bullish pattern that only sees the price building energy around a horizontal line.

That horizontal line isn’t mandatory to look like in the chart above. The notion of an ascending or descending triangle comes from the stock market, where the patterns were identified for the first time.

Due to the higher volatility on the Forex market, the price rarely hesitates and consolidates around a horizontal line. Instead, the line has a slightly ascending or descending angle, keeping the notion of an ascending or descending triangle alive.

Conclusion

Ascending and descending triangles are continuation patterns. Keep in mind that the Forex market, despite the impression it gives, it consolidates most of the times.

When this happens, like it does in over 65% of the cases, a triangle forms. Triangles are the favorite way for the market to consume time, and they can be either reversing or continuation patterns.

If the trend continues in the same direction, an ascending or descending triangle formed. All traders must do is to correctly interpret the break and jump on a trade when the trend resumes.

 

Elliott Waves 101

One of the most famous trading theories, the Elliott Waves Theory has its roots back in the 1940’s.

It was then when Ralph N. Elliott fell ill. Out of lack of preoccupation, he took a closer look at the stock market, having a firm belief in mind: the market is the sum of human behavior.

With that idea, we laid down a set of rules that would become the pillar of the Elliott Waves Theory. His belief proved to be right: a quarter of a century later, the Elliott Theory is the only one still to interpret the market through a human behavior analysis.

Over the years, it suffered some changes. If you think of it, it is only reasonable.

The theory was based on the stock market moves, but the stock market changed in time. Just as the stock market changed, some other financial markets appeared.

Therefore, trading Forex with the Elliott Waves Theory is like applying a quarter of a century old theory to a new market. Yet, it works, because the human factor is still present.

Elliott

Elliott Waves Theory Main Rules

Elliott split the market moves into two main categories: impulsive and corrective waves. In other words, a move is either impulsive or corrective.

The logical process implies that if the rules of an impulsive wave aren’t respected, the move must be corrected. As such, all traders must decide is if a specific move has impulsive characteristics.

Here are the rules that make an impulsive wave:

  • An impulsive wave is a five-wave structure labeled with numbers: 1-2-3-4-5
  • Out of the five waves, the 1st, 3rd and 5th ones are impulsive waves too, while the 2nd and the 4th ones have corrective structures
  • The 3rd wave cannot be the shortest one when compared with the 1st and the 5th waves
  • There’s at least one extended wave in an impulsive move. To extend, a wave must be bigger than 161.8% when compared with the other impulsive waves of the same degree.
  • No parts of the 2nd wave should retrace beyond the start of the impulsive wave.
  • The 2nd wave can’t be a triangle and it typically retraces between 50% and 61.8% of the 1st wave
  • The 4th wave can be any corrective pattern
  • No overlapping between the 4th and the 2nd wave is allowed

Any single rule of the above set must be respected. If not, the move doesn’t have impulsive characteristics. Hence, it’ll be corrective.

For a corrective wave, the theory becomes a bit more complicated. Elliott found that the market spends most of the time in consolidation or ranges.

That’s true for today’s Forex market too. Think of it: the Asian sessions typically show a small range, and, ahead of crucial economic events, the market just doesn’t go anywhere.

Those are corrective waves, and the underlying Elliott rules to explain them are:

  • Elliott divided the corrective waves into simple and complex ones
  • Simple corrections have three-wave structures labeled with letters: a-b-c
  • The market may form only three types of simple corrections: triangles, flats, and zigzags
  • Complex corrections have at least one intervening x-wave (connecting wave)
  • The intervening x-wave is a corrective wave of a lower degree

An Elliott Wave count, therefore, is easy to read. If you see numbers on a chart, the trader labeled impulsive activity. With letters, he/she showed corrective waves.

Conclusion

Like anything that seems to be simple, it is just an illusion. The rules laid down in this article only highlight the theory’s essence.

Going down into more details, the Elliott Theory involves failures, various patterns on different cycles, it breaks down the corrective and impulsive waves in different patterns, and so on.

Future articles will deal with the complexity of it. For now, just remember that it is the only theory to look at how we, as traders, control greed and fear. Or, how we deal with the two.

Simple Price Action Technique to Spot a Trend Reversal

Every trader wants to ride a trend. The trend is your friend, right?

That’s true all the time. But, there’s a catch.

The Forex market doesn’t trend that much. I mean, it sure does, but what seems like a trend, turns out reversing when no one expects.

From a money management point of view, traders overcome a reversal by trailing the stop. However, this ends up exiting on the first swing against the primary trend.

Or, in a trend, there no such thing as a straight line. The market moves and corrects. After all, this is the very definition of a trend.

Namely, connecting two points. But, those points appear when the market corrects the primary trend.

Simple Way to Spot a Trend Reversal

How do traders know when a trend ends? Or, when a new one starts?

Typically, what traders do is to wait for the main trend line to break. While this is correct most of the times, it often gives false signals.

What if I told you there’s another, more exciting way, to look for a trend reversal, without even using a trend line? Here’s how.

Take Clues from the Previous Trend

Because the market moves in waves, the move of the primary trend gets to be corrected by smaller counter trend ones.

Effectively, this means that in a bearish trend, the moves in the main trend will make lower lows, while the counter-trend moves will make lower highs.

For as long as this series of lower lows and lower highs holds, the trend won’t reverse. No matter what fundamental analysis or some other kind of study points to the upside, the trend will keep going.

In a bullish market, the upside moves will see the price continually making higher highs. At the same time, the pullbacks won’t break the previous low.

That’s a bullish trend, and the market won’t reverse until the series of higher highs and higher lows ends. As such, the first clue that a trend will change is when the market breaks the previous trends last lower high or higher low.

Let’s look at the EURUSD recent daily chart. For the whole summer of 2017, it moved aggressively, in a bullish trend.

However, before that, traders could have spotted the previous trend’s reversal. Just use the same steps explained above, and you’ll end up with the chart below.

Trend Reversal

From left to right, the market formed a bearish trend. And, the most recent lower high held on the first bullish attempt.

However, the second attempt saw the EURUSD breaking the previous lower high. That’s bullish, as it signals a new trend started. Or, it shows the previous one ended.

As such, to respect the new higher lows and higher highs series that corresponds to a bullish trend, the previous higher low must hold.

How about a trade? When can traders go long?

For this, we need a trend line. Just connect the first two points of the new trend line, and when the price hits the line, that’s the perfect place to buy.

Price Action

Because the previous higher lows must hold, that’s the stop loss. As for the take profit, look for a risk-reward ratio that is bigger than 1:3.

Considering this is the daily time frame, this simple price action technique gave excellent results.

Conclusion

Technical analysis doesn’t have to be complicated. Traders often get lost in so many indicators and trading theories that they forgot the bread and butter of technical analysis: trend reversals and trend riding.

As always, price action comes to help. Only use the logic of lower lows and lower highs in a bearish trend, and higher highs and higher lows in a bullish one. You’ll be on the safe side of the market.

 

 

 

Inflation in Forex Trading

Inflation or the CPI (Consumer Price Index) is one of the most important economic releases. If not the most important one.

inflation

During a trading month, the economic calendar is filled with data. Traders use the data to interpret an economy.

Next, based on the economic differences between two economies, they sell or buy a currency pair. For example, if the U.S. data comes out stronger than expected, traders will buy the dollar.

But, there is so much economic data to be released on a monthly basis, that traders get confused. What matters the most for a market?

The answer to this question comes from knowing what matters for a central bank. Knowing what a central bank targets helps traders filtering the economic data.

A Central Bank’s Mandate

Central banks around the world have a clear mandate. Most of the times, it relates to inflation.

As such, a central bank’s goal is to create inflation. However, not by all means. Moreover, not any kind of inflation is desired.

For an economy to grow at a normal rate, inflation must sit around 2%. So, central banks in major economies around the world target the 2% level.

A normal central bank’s mandate looks to bring inflation below or close to 2%. Any move lower will be met with easing policies. Any move higher, with tightening ones.

The more inflation deviates from the target, the more aggressive the central bank’s actions will be. Recently, inflation declined on a global scale.

Oil and Inflation Expectations

A major source of inflation is the oil price. As a rule of thumb, when oil falls, inflation declines all over the world.

And, the other way around is true as well. When the price of oil rises, inflationary pressures pick up too.

The recent years showed the oil price moving aggressively lower. From values above $100 to around $30. In a matter of months, inflation fell in major economies around the world.

So dramatic the move lower was, that it reached negative levels in most economies. In the Eurozone, for example, deflation (when inflation moves below zero) appeared.

A central bank has only one way to respond to such conditions. To cut rates and ease monetary policy.

So, the ECB did just that. It cut rates all the way down to negative territory. And, it eased the monetary policy by starting a bond-buying program.

Even to this day, the program still runs. While inflation picked up a bit, it still rests well below the ECB target (below or close to two percent).

Why Do Forex Traders Care?

Traders always look for clues about what the central bank will do next. That’s what matters in Forex trading: the interest rate level and the monetary policy changes.

Inflation, or the CPI, is the one release that tells what the central bank will do with the rates. As such, traders expect the CPI data and position for the central bank’s decision.

That’s fundamental analysis in Forex trading. And inflation is the most important economic news to watch.

Conclusion

Forex traders mark the CPI releases on the economic calendar. When CPI gets out in UK, Eurozone, Japan, the United States, Australia or New Zealand, volatility is on the rise.

The more important the economy, the bigger the expected volatility is. The more the actual release differs from the expected one, the bigger the volatility.

All in all, when Forex traders look for clues about future interest rates, they look at the CPI level. That’s all that matters for most central banks.

Morning and Evening Stars in Forex Trading

Technical analysis as we know it today changed dramatically. Personal computers are responsible for it.

However, some patterns stand the test of time. No matter the market and the changes in execution, some patterns survived. Japanese candlestick techniques are such patterns.

Before discussing one of the most popular Japanese patterns, it is worth mentioning that, mostly, they are reversal ones.

As such, they form at the end of a trend. Either a bullish or a bearish trend, at the end of it, the market will form some sort of a Japanese reversal.

The Japanese candlestick patterns are made of a single candle or a group of candles. Their power is proportional with the time frame they appear on.

Stars are powerful reversal patterns. The bigger the time frame they appear on, the more powerful the signal is.

Trading Forex with Morning and Evening Stars

A star is a group of three candles. The name of the star comes from its implied future direction.

Having said that, a morning star is a bullish pattern. Hence, it forms at the end of a bearish trend. Remember? It shows a reversal.

On the other hand, an evening star is a bearish pattern. It appears at the end of a bullish trend and shows weakness.

However, both morning and evening stars will have a difficult time to reverse a trend. Typically, after a Japanese reversal, the ones that trade in the direction of the underlying trend will try to take the highs (in an evening star) or the lows (in a morning one).

This happens from time to time. But it doesn’t mean traders should disregard the patterns.

The secret is to integrate the morning and evening stars trading with a proper risk-reward ratio. It means at least 2 or 2.5 for every pip risked.

In doing that, discipline takes control over the trading process. As a result, Forex traders have more chances to survive in the long run.

How to Trade a Morning or an Evening Star

As mentioned earlier, the pattern has three candles. The first one is a strong candle in the direction of the original trend. It has a strong green body (in an evening star) or a strong red one (in a morning star) and a very short shadow.

The candle in the middle is either a hammer or a doji. In both cases, it shows reversal conditions. Or, at least hesitation.

The last candle moves in the opposite direction when compared to the original trend. It has a strong body, at least like the first candle has.

evening star

Above there’s an evening star that respects all the rules described. There’s a strong, bullish trend, and at the end of it, a group of three candles that form the evening star.

The market reaction speaks for itself. Unfortunately, look at the time frame. It is the hourly chart.

As such, chances for the pattern to survive are slim. Moreover, there’s no retracement after the third candle.

Typically, traders look for bulls to put up a stiff fight and retrace at least fifty percent of the pattern. That’s a great place to go short. However, this pattern here lacks that retracement.

Yet, the market retraced and, for the hourly time frame, it still offers a nice risk-reward ratio.

Conclusion

Japanese candlestick techniques are great reversal patterns. They work great, especially on the bigger time frames.

But the secret comes not from one’s ability to spot them. There are clear rules for that.

The key is to integrate the patterns in a strong money management system. That’s the only way to profitable Forex trading.