TRADING SECRET NO. 3 How to combine two simple tools to capture big trending moves, especially in currencies

Transcription

1 TRADING SECRET NO. 3 How to combine two simple tools to capture big trending moves, especially in currencies 25 Currencies have a reputation for being markets that trend well. And, every business day over a trillion dollars worth of foreign currencies are traded. No, that s not a typo. I said trillion with a T. Here s a great technique that works especially well with currencies. When I trade, I look for compound signals where two or more indicators are all telling me to buy or sell. Check out the chart below. This is the Canadian Dollar. The swooping line that appears below the price bars is a 40-day moving average of this market s closing price. The indicator that Fig. 3.1 Canadian Dollar appears in its own window at the bottom of the chart is 10-day Momentum. Why these two tools in particular? The 40-day moving average of the closing price is my trend defining tool. The basic rule is: When price bars are above the 40-day MA, the trend is up. When price bars are below the 40-day MA, the trend is down. There are other tools and indicators designed to find trending markets. Welles Wilder s Directional and Average Directional

2 26 Movement Index (DMI/ADX) is one example. But, I prefer the simplicity and quick visual impact of the 40-day moving average. I learned this technique from a trading colleague of mine. This gentleman is a former commodities broker from New York whose clients included a large number of commercial Cotton traders. They used a 40- day MA to verify the direction of the trend. There are between 20 and 22 trading days in a calendar month. So, a 40-day MA is drawn from about two month s worth of data. Based on my own experimentation, anything shorter tends to be too short. There are too many whipsaws back and forth. And, anything longer tends to be too long. When a market changes trend, there is too large of a retracement of the previous trend before the new trend can be confirmed. Simply stated, the Momentum indicator measures the amount of price change over a given period of time. It gives several types of signals, but the most important, and easiest to spot is the crossover. That is, when the indicator line crosses above or below its horizontal Zero line. In a trending market, we look for crossovers in the direction of the trend. Now, let s take another look at the Canadian Dollar. Notice that I have drawn a vertical dotted line through the price bar for August 29, 2003 (on the left side of the chart). Two things happened that day: first, Fig. 3.2 Canadian Dollar, again

3 the price closed above the 40-day moving average; and second, the Momentum line closed above Zero (it s a bit hard to see in black and white, but trust me, it s there). This is a perfect example of the type of compound signal I mentioned earlier. Price closing above the 40-day MA tells me that there is good chance this market is moving into an uptrend. And, Momentum closing above Zero tells me that this market s internal energy is rising. After spotting the compound signal of August 29 th, I would place my order to buy a contract on the open of the next trading day. August 29 th was a Friday, so I would enter on the long side at the open on Monday, September 2 nd at around By the way, that price means that I can buy one Canadian Dollar for $ U.S. Using just these two indicators, I would stay long until October 31 st. That s the day I have marked with the solid vertical line near the right side of the chart. Price is still well above the 40-day MA, but notice that Momentum has closed below Zero. This instantly tells me that even though this market s uptrend is still technically intact, its internal upward energy has dissipated, and it is about to move down. I would place my Autopilot Sell Stop one tick below the low of October 31 st (Part Two of my course is totally devoted to all my risk management methods). As you can see, the price gapped down on the next day s open. So, I would have been stopped out around And note, four days later price closed below the 40-day MA, confirming Momentum s crossover warning. This trade lasted almost exactly two months, and my gross profit before transaction costs would have been about $3,160. As of this writing, the margin deposit for the Canadian Dollar is $1,013. As I explain in my course, if you use my Stop Placement Protocols, your maximum theoretical risk on any futures trade tends to be about the same as the margin for that market. So, I would have made about a 300% return in two months. This trade is hardly unique. Let s take a look at the Euro Currency Unit on the next page (Fig. 3.3). By the way, don t call this market the Euro, or it will be confused with the Eurodollar which is an interest rate vehicle, not a Currency. The Euro Currency Unit is known as the Euro FX for short. The FX stands for Foreign Exchange. The vertical dotted line on the left runs through the price bar for 27

4 28 Fig.3.3 Euro Currency Unit November 13, This was the second day that price had closed above the 40-bar MA, and the first day that Momentum closed above Zero. Remember, I m looking for a compound entry signal. I would buy a contract at the open on November 14 th, and probably would have been filled around (i.e., it would take $ U.S. to buy one Euro FX). About two months later, I have placed the vertical solid line on January 16, On that day, the price quickly dropped down to but not below the 40-day MA. Again, the uptrend remains technically intact, but Momentum has shown me the reversal in internal energy by closing below Zero. Based on my Money Management Protocols, I would have been stopped out on January 23 rd at around Gross profit on this twomonth-plus trade: $11,300. Do I have your attention yet? Okay. Let s look at one more market. This time we ll make it the British Pound on the next page (Fig. 3.4). There are two long trades on this chart. The first vertical dotted line on the far left runs through September 11, Momentum had already been above Zero for a few days, but this was the first day

5 that price closed above the 40-day MA. I would have gone long on the open of September 12 at about (it takes $ U.S. to buy one British Pound). I could have stayed in this long trade until November 5 th (the first vertical solid line near the middle of the chart). On that day, price was still above the 40-day MA, but Momentum closed below Zero. So, I would place my Stop just below that day s low. I would have been stopped out the next day around Gross profit on trade #1: about $4, The next dotted line near the middle of the chart is about two weeks later at November 18 th. Price had remained above the 40-day MA the whole time. But, this was the first time that Momentum closed back above its Zero line. I would buy a contract at the next day s open around This trade took me all the way into the New Year. The next solid line on the right is at January 23, 2004, a Friday. Momentum closed below Zero, so I would move my Stop to just below the low of that day. Price moved lower the following Monday and hit my Stop at about Gross profit on trade #2: close to $7,975. So, I ve shown you just four trades in three markets using two basic technical tools where a trader just like you might have made over $26,000. I can also show you: Fig. 3.4 British Pound u Which moving average is better to use for swing trading. u How using multiple moving averages of different speeds can help you see the market s internal energy wax and wane. u How you can adjust the parameters on Momentum for longerterm position trading and stock trading. u Other combinations of Oscillators and Overlays that give great entry and exit signals in other markets and other time frames. 29