STRATEGIES FOR FOREX MARKET PREDICTIONS IN 2011 By: Russel Glaser, Chief Market Analyst: FOREXYARD Date: February 2011 In this Issue: 1. Incorporating Long Term Charts for Market Predictions 2. What is a Long-Term Chart? 3. Identifying Long-Term Trends 4. Long-Term Chart Patterns 5. Support and Resistance Levels 6. Real Money 7. Taking a Long Term Outlook 8. Conclusion
1. Incorporating Long Term Charts for Market Predictions When following currencies and commodities, traders often have the problem of short-sightedness and fail to look at the big picture. This failure may come as the inability to look at the macro-economic side, the geopolitical landscape, or simply the charts. Traders must maintain a holistic viewpoint, examining a currency s worth from an extended time frame. This principle holds true for all traders no matter what strategies they employ whether it is a trending strategy, swing trading, or intraday. By identifying the long-term history of a currency pair, traders will come to a more thorough understanding of where a pair has been, and where the pair may go in the future. This process involves examining a currency pair not only from the short-term charts, but also from the longer-term view as seen on the weekly and monthly charts. Using multiple time-frames to conduct technical analysis will provide a trader with a more precise view of the financial instrument s previous price movements as well as more tools to analyze potential future price changes. The main advantage to multiple time-frame analysis, as opposed to single time-frame analysis, is its ability to allow a trader to see not only what has happened in the immediate past, but also in the previous weeks, months, and years. Examining a currency pair from a long-term time-frame can provide valuable insight as to the pair s future movement. Caveat Prior to this discussion, it should be noted that the use of long-term charts and patterns are best kept on the analysis side of the business. Traders can find long-term charts helpful in planning trades, identifying major trends, as well as locating key resistance and support levels. However, entry and exits should be made while using the daily or hourly charts.
2. What is a Long-Term Chart? The definition of a long-term chart is subjective. To an intraday trader who is in-and-out of a position in less than 30 minutes, a long-term chart may be the 4-hour chart. To a swing trader who holds a position for a two-to-three day period, a long-term chart may be the weekly chart. For this discussion we will define a long-term chart as any chart that presents data in a time-frame, per bar, greater than one day. Many market technicians refer to the weekly, monthly and even yearly charts as long-term. However, for this discussion, when we refer to long-term charts, we will be referencing only the weekly or the monthly chart. 3. Identifying Long-Term Trends Examining a market from a long-term perspective allows for a trader to understand the technical environment the pair has been trading in as well as identifying if this environment may continue. Is the pair trending higher? Lower? Or is the FX pair moving sideways in a range-trading environment? Dow Theory says there are three types of trends: Major, Intermediate, and Short-Term. John Murphy, one of the better-known names in technical analysis takes this one step further. Murphy says that Major trends are any trending environment that lasts for more than 6-months. Intermediate trends extend from 3-weeks to 6-months, and Short-Term trends qualify as anything less than three weeks 1. Using the long-term charts, a trader has the opportunity to identify the direction the instrument has been moving not only over the previous month, but for the last few years. Only then can a trader differentiate the Major longterm trend from the Intermediate and Short-Term trend. To identify the long-term trend, a simple trend line can be drawn on the weekly or monthly chart. For an uptrend, the trend line should be drawn underneath the lows of the bars, or candlesticks, taking into account all of the price action. For a downtrend, the trend line should be drawn above the highs of the bars or candlesticks. 1 John Murphy, Technical Analysis of the Financial Markets (New York, NY: New York Institute of Finance, 1999) 52.
What added value does identifying the long-term trend provide for traders? Applying long-term trend analysis can show what direction the currency pair has been moving over time. Rather than simply looking at the daily chart and seeing that the trend is up, an analysis of the weekly and monthly chart helps pinpoint what kind of phase the market is in. Is upward movement part of an Intermediate uptrend or perhaps only a correction in a Major longterm downtrend that has been in effect for the past 3 years? A 3-year downtrend of the USD/JPY. A period of consolidation shows the formation of a falling wedge pattern towards the end of the chart. By recognizing the long-term direction a currency pair is taking, a trader can adjust his tactics to trade in-line with the Major, Intermediate, and Short-Term trends, while finding better entry opportunities at the same time.
4. Long-Term Chart Patterns Many traders apply trade setups based on known chart patterns. Examples of these patterns are triangles, wedges, rectangles, and head-and-shoulders reversals. These chart patterns appear not only on the hourly and daily charts but also the weekly and monthly. Some of these chart patterns have greater rates of success than others (this topic will not be discussed here). What is key to remember here is that the appearance of a chart pattern on a long-term chart carries more significance than its appearance on a short-term chart. For example, a head-and-shoulders reversal pattern forms fairly often on the hourly chart, but many times this turns out to be a pause in the trend as the price fails to reverse and continues in the original direction of the trend. Some patterns may last for several months and even years with FX pairs trading between known boundaries. These long-term patterns may not be readily identifiable on the daily or hourly charts due to the amount of time it takes for them to form. A breakout from a triangle pattern on the monthly chart. Following a breach of the lower line, notice how the price reverts back to the lower line which then serves as resistance.
When an FX pair breaks out of one of its patterns, it often leads to the reversal of a long-term trend or a resumption of a previous trend. It is these types of price level breaches that present themselves on the long-term charts that form the large price moves that many traders are after. This leads us into the next topic. 5. Support and Resistance Levels Long-term charts help to identify important support and resistance levels. Typically, retail traders find their support and resistance levels from the daily and hourly charts. While intraday price levels play an integral part in identifying entry and exit prices for trade setups, a close, or a high price on a weekly or monthly chart carries much more significance in the market than a close on the daily. As such, an FX pair will often revert back to a certain price level, whether it is a support or a resistance line. Many times the pair will fail to breach this price at least once. For example, if an FX pair rises, but fails to breach above an identified resistance level at a certain price, and the pair then proceeded to fall; when the next bullish move comes and the pair approaches this price again, the trader who is only looking at the hourly chart would not be aware of this significant long-term resistance level. Only the trader who keeps an eye on the long-term picture will be able to identify this key resistance level and plan his or her trades accordingly. Above is an example of a previous support level turning into a resistance level.
One possible reason for the creation of resistance and support levels is a big seller whose actions move the market and cannot buy or liquidate large positions at one time without drastically affecting market prices. The order put through is so large that the seller or buyer influences the market price with the size and strength of the order. Therefore, the large players who are patient will wait until the price comes back to their target levels to continue with the buying or selling of this large position. 6. Real Money The term smart money is often used to identify what the informed players are investing in. While these investors aren t always 100% correct with their investment calls, they have the ability to move prices with their market transactions. These market participants may be large investors in the FX, fixed income, or equity markets and usually are defined as central banks, investment banks, insurance companies, pension funds, sovereign wealth funds, and some larger hedge funds/commodity Trading Advisors (CTA) 2. This group of traders would be known as real money Real money investors have a definitive set of advantages over the average retail FX trader. These bodies have access to the best human capital and economic minds in the business, technological advantages with super computers that carry out complex algorithmic trading, and the ability to monitor global capital flows which identify the directions of the major FX pairs and crosses. These market players are huge investors that push around billions of dollars. When one of these players puts on a position, the market reacts accordingly. These large investors are not looking to make 10 pips on a position; they are also not looking to make 100 pips. These market players are out to make thousands of pips on a trade. These traders are looking for large price moves, many that come with major trends 3. Such price movements are not seen in a 15-minute time-scale, but over weeks and months. Using a chart greater than the daily chart allows for the forecasting of these major trends that simply is not possible via the intraday charts. 2 Global Finance: World s Best FX Providers 2011: Best Foreign Exchange Research & Analysis. January 2011, <http://www.gfmag.com/archives/133-january-2011/10959-worlds-best-fx-providers-2011-best-foreign-exchange-research-aanalysis.html#axzz1cfmy92uo>. 3 Ed Ponsi, Forex Patterns and Probabilities: Trading Strategies for Trending and Range Bound Markets (Hoboken, NJ: 2007) 99.
7. Taking a Long Term Outlook When the Forexyard team of Dealers, Analysts, and FX Salesmen talk trading strategies with clients, very rarely does a trader ask what the long term outlook for a currency pair is. Most traders are more interested in the forecast for the next few hours which is a terribly difficult prediction to make. Too many factors can influence the value of a currency in such a short period of time. One piece of economic data that comes in below economists forecasts and market sentiment will rapidly shift, derailing any potentially accurate short term forecast. This is also directly related to filtering out noise from one off events that impact the short term value of a currency. A worse than expected GDP report or civil disruptions in the Middle East may move the markets for a short period of time, but these one off events typically do not bring about changes in the long term trend. For those traders that are able to identify long term trends using a combination of long term charts, moving averages, and oscillators, it can put a trader at an advantage over those that see only the short term consequences of events. When a trader comes to the conclusion that a particular currency or commodity should outperform, taking these one-off events into account for long term forecasting, on the weekly and monthly charts, these events appear to be buying opportunities rather than a chance for a quick short term sell.
8. Conclusion Adding such tools to a trader s repertoire allows him to possess the capability for deeper market analysis, and a better view of price movements. Currently there is a glut of indictors, oscillators, and soothsayer signals. Many times these tools are used by traders at inappropriate times or interpreted inaccurately. By looking at a currency pair from a long-term time-frame and identifying if the pair is in a trending environment or range-trading phase and acknowledging the major support and resistance levels within these trends grants a trader the option to dig deeper into the shorter time-frames and plan his trade. Then, following a shift from the long-term time-frame to a short-term time-frame, a trader may mark entry and exit prices on the daily chart and hourly chart, entering a trade with confidence that the trade was placed in line with the long-term technical factors. Have you opened your FOREX trading account to take advantage of this potential? SIGN UP FOR A PRACTICE ACCOUNT TODAY