Breakout Fading

Fading breakouts refers to trading against breakouts. When we believe that breakouts from support and resistance levels to be false and unsustainable we fade breakouts. Suppose you believe that the currency prices will not be able to follow through action in the direction of the breakout. You trade in the opposite direction of the breakout.

False breakouts are a bane for breakout traders but boon for breakout faders. False breakouts are also known as fakeouts. Fading breakouts tends to be more effective as a short term strategy. Fading breakout is not meant to be a long term strategy.

The resistance level attracts the seller’s enthusiasm for shorting and it prevents the price action from advancing higher. Support level attracts the buyer’s enthusiasm for higher bids. It prevents the price from falling further down. Support and resistance are seen as the price floor and the price ceiling respectively.

It is perfectly logical for the crowd to think that if the support level is penetrated, then the price action should move downward. The crowd is more likely to sell than to buy when the price action breaks the support level from above. The idea of trading breakouts appeals to many independent traders especially those new to currency trading. The crowd likes to trade the breakout.

The crowd is more likely to buy than to sell when the price action breaks the resistance level from below. The opposite is true of a price break above the resistance level. The crowd usually concludes that if the resistance is broken, then the prices are more likely to advance higher in the rally.

You will find clusters of stop loss orders placed around both the support and resistance levels. These stop loss orders are placed by traders who have brought near the support level or have sold near the resistance level. Now you can also understand why there tends to be large number of entry stop orders placed just above a resistance level and also placed just below a support level.

When the currency prices crosses below the support level, long positions will be stopped out. Similarly, short positions will be stopped out when the price action breaks out above the resistance level.

You will ask why most breakouts fail? The fact that smart traders need to take the money from the novice and inexperience traders is one of the most important reasons why most breakouts fail. Always remember, it does not always pay to have the same mentality as the crowd. The majority will cash out of the trading game broke.

Smart money belongs to the big players who have a couple of tricks to sabotage the crowd. The crowd holds the dumb money with the weak hands. Money has to be made from the majority. Not from the minority who got it right and know how to play the games. It causes vertical rallies or declines when the crowd scrambles to get out of their losing positions. Most money is made when the crowd turns out to be wrong.

A Tax on Forex Trading?

On June 1, the Forex Blog reported that Brazil is considering a forex tax on capital inflows as a way of discourage the inflow of speculative capital that is causing the Real to appreciate. It turns out that Brazil is not alone; England and France, among others, are also mulling taxes on forex transactions. Their goal is not necessarily to discourage capital inflows, but rather to raise money to fund projects that would otherwise not be viable under current budgetary conditions. The UK “levy would raise $30bn-$50bn a year - enough to double spending on health in low-income countries.” The French plan, meanwhile, would “involve taking 0.005% of the proceeds of currency transactions, perhaps on a voluntary basis, to benefit global aid projects.”

While Brazil and England/France appear to be pursuing different ends, together their plans capture the idea behind the “Tobin Tax.” Originally proposed by Nobel Laureate James Tobin after President Nixon declared the end of the gold standard, the tax would be levied on all forex transactions with the proceeds deposited in forex stability funds. One of the most popular versions would only impose the tax during periods of volatility (i.e. speculation) so as not to punish those exchanging currency for “mundane” reasons.

While still a fringe idea, the tax initially gained momentum following the 1997 Southeast Asian economic crisis, and has found new followers in the wake of the ongoing credit crisis. Consider the unprecedented volatility in currency markets of late, manifested in wild daily fluctuations.

Even the US Dollar, the world’s reserve currency, has been on a veritable roller coaster of late, rising and falling by 10% in a matter of months. Prior to the rise of forex speculation (already a $1 Quadrillion/year market!), it was rare for a currency to move that much in a year. Given that such speculation probably accounts for 90% of daily turnover, it seems obvious as to who is causing this volatility.

Don’t get me wrong; there’s a role for speculation in the forex markets, just like there’s a role for speculation in all securities markets. When markets function efficiently and players act rationally, currences should and will reflect economic fundamentals and act to minimize global imbalances. Due to the rise of the carry trade and the herd mentality, however, the oppose often obtains in practice. This can cause currency runs and or artificially inflated currencies that compel Central Banks to act counter to the way they otherwise would (i.e. by raising interest rates rapidly to deter capital flight, crimping economic growth.)

A Tobin tax would work both to minimize speculation in the short-term (by taxing trades) and promote stability in the long-term (by providing Central Banks with funds that they can use to fight speculative “attacks.” Besides, given that forex traders already enjoy favorable tax treatment - i.e. taxed below the short-term speculative rate - it wouldn’t be the end of forex trading as we know it.

Currency Correlation with Stock Market Remains Intact

In my experience, currency markets (and most other securities) markets tend to be governed by trends. There are short-term trends, long-term trends, and medium-term trends. Granted, this is an oversimplification, but generally speaking, if you were to chart a given currency pair, you could characterize its fluctuations in accordance with this paradigm.

Short-term trends are typically the focus of technical analysts, who ignore the broader forces affecting a given currency pair and instead try to discern slight trading patterns. Long-term trends, on the other hand, are the purview of economists, and reflect interest rate and growth differentials. Medium-term trends, meanwhile, unfold over a period of months (sometimes shorter, sometimes longer) and require a combination of technical and fundamental analysis to discern and trade successfully. With this post, I want to focus on the current medium-term trend, which is that of declining risk aversion.

I would not use the expression “old” news to describe the stock market (and accompanying) rallies that have taken hold broadly since the beginning of March, since it’s still be unfolding. Given that hindsight is 20/20, it now appears that the (perceived) stabilization of the US financial sector provided the impetus for the rally. In the weeks that followed, investors pulled an about-face and piled back into risky sectors and trades. The US stock market rapidly reversed course and is now trading around the level following the Lehman Brothers collapse last October.

The rally in March marked the end of one medium-term trend and the beginning of a diametrically opposed, but conceptually similar medium term-trend. Sorry to make it sound complicated, since it’s actually quite simple; in an overnight switch, investors went from being bearish and risk-averse to bullish and risk-seeking. These mindsets (and the switch between) is also reflected in currency markets. You can see from the chart below how the Australian Dollar, British Pound, and Down Jones Industrial Average have tracked each other closely over the last year, and moved in lockstep since March 3.

I suppose you could say that the correlation between US stocks and currencies represents one continuous long-term trend, and based on this chart, you would be making an accurate assessment. However, it’s equally important to unveil the underlying mindset that is driving both stocks and currencies, and is causing them to move in tandem. This is a nuanced distinction, and an important one to understand. There is a difference between a change in sentiment that causes investors to simultaneously pour money into risky investments (stocks and currencies, etc.) and a change in sentiment that causes a stock market rally and consequently, a currency rally. In the first scenario, both currency traders and stock market investors are in tacit agreement over risk-seeking, while in the second scenario, currency traders are uncertain, and hence taking their cues from the stock market.

Part of what makes a good currency trader is discerning which of these scenarios accurately describes the current reality in forex markets, so that a viable forecast and trading strategy can be implemented. Scenario 1 suggests that if the stock market rally falters, risky currencies will also decline. Scenario 2, meanwhile, suggests that currency traders would maintain their positions even in the event of stock weakness, which would cause the correlation between forex and the S&P to break down.

Source:www.forexblog.org

3-D TRADE EXECUTION IN FOREX

Short-term traders often focus on large elements of the pattern cycle and miss important signals buried within intraday price movement. This relativity error forces them to wait on the sidelines until these major swing points are reached and participants from broader time frames enter the game. Rather than wait, traders can locate good setups by reading reversal and breakout patterns within very short periods of cyclical market movement. Chart analysis works best when several time frames are combined to identify important swing points and breakouts. But once the short-term trader identifies the broad framework of support and resistance, profits come from predicting how the next few minutes or hours of market action will play out. Let's trade through a small pattern cycle following a powerful Intuit (INTU) rally. As INTU slowly pulled out of a 9-month base in mid-October, few realized it was headed into a quick price triple. Typically, short-term traders become aware of dynamic rallies very late in their development. The majority then engages in momentum strategies to chase the big move. But risk is very high at this stage of the broader pattern cycle. As stocks go parabolic, traders get caught in sharp downdrafts that empty pockets as quickly as they are filled.

Smart technicians use major reversals, such as the one INTU printed at 60, to signal the start of predictable swing trading conditions. The downswing generates fear and provides a perfect environment for well-defined pattern and support-resistance formation. But don't rush into poorly defined entries. Be patient and wait for the right opportunities to develop. While good short sales print on the downdraft, we'll concentrate on going long with the uptrend. A large crowd always misses the boat on strong rallies and sees any pullback as a good entry. Our first job will be to wait until a bottom pattern prints and then join them. This can occur in a few minutes but routinely takes several days to form on a typical 15-min or 60-min chart. We are fortunate with INTU. The appearance of a symmetrical triangle quickly defines a possible bottom and clear breakout point. Note how our bottom support line actually violates the 11/30 low. The markets rarely offer perfection on very short-term patterns. Traders must be skilled enough to draw useful trendlines based on limited and conflicting information. If we have done our drawing well, the gap on the morning of the 2nd will be immediately recognized as a breakout from that triangle and completion of the bottom reversal pattern.

The market does not give away its gifts easily. Traders that buy the INTU morning gap face considerable whipsaw action until the lunch hour. Note the common 3rd bar reversal just 10 minutes after the market opens. This sets the stage for traders to apply a simple 1st hour range breakout strategy and look for an entry just above the reversal high. The pattern also offers swing traders safe entry on both the first test of the morning gap and the double bottom test later that morning. However those that enter at bottom support then risk considerable profit if they choose to hold to new highs. Exit this classic swing trade just before the top of the first hour range and consider the setup for a new breakout trade on its own merits.

The safest breakout entry takes place just minutes before the move above the morning highs. But how will the trader know to buy? A well-trained eye recognizes the small cup action of the tall bar just prior to the breakout. The morning pattern gives up its secret here, leaving the smart trader with 2-3 minutes to enter quietly at the bid through a favorite ECN. Also note the small ascending triangle just above the breakout point. New breakouts typically pause for 4-6 bars before momentum shoots out in a tall candlestick. The next morning opens with a powerful opportunity for traders. It takes very strong demand to break the rising trendline of a price channel. For this reason, channel breaks often produce very tall price bars immediately following the initial signal. Note how much of the break takes place in the first 30 minutes of trading. This offers a very small window for the trader to get on board safely.

INTU pattern cycles shift back and forth through charts of different time frames. If you get lazy and only focus your attention on a single segment, your level II screen may flash a breakout but you won't understand the source or reason. Without the right information, odds increase that you'll jump in at the wrong time and buy a top or sell a bottom. Good traders know when to stand aside. As INTU approaches 60, long side trades become very risky. But after the strong momentum of the opening move, shouldn't we expect another long thrust after a short pullback? At this point, our strategy relies on the broader pattern cycle to provide our guidance. Looking back, we realize that price has returned to the beginning of the original reversal and stands right at a potential double top. Smart traders never buy into a double top.

But we should not sell short at this level either since the uptrend remains well intact. Our best tactic is to pause and let the market tell us what will happen next. Through the balance of the session, INTU sketches a narrow consolidation flag. Here at the end of the week, the broad 60-min chart resembles a classic cup and handle pattern. Should we now buy or sell? Let's wait for Monday and see what the market tells us to do. Source:www.hardrightedge.com