Practical Trend Trading Made Easy

 

 

 

A Note from Chris Hi, this is Chris Lee from PipMavens.com and I’d like to congratulate you for taking the next step in furthering your Forex trading education! Candlesticks are one of the most misunderstood aspects of Forex trading, and this book was designed to teach you how to interpret them properly. You’re not required to memorize anything here; instead, I’m going to show you how you can understand any market situation simply by looking at a bare trading chart. Before we begin, there’s one thing I’d like to point out – the concepts that I’ll reveal in this book have been carefully presented to be as ‘easy to understand’ as possible. However, don’t confuse simplicity with ineffectiveness. The trick is in being able to understand, appreciate and translate these concepts into real profits. profits. That’s what most people fail to do. Many think  they  they know how to read candlesticks, but yet keep losing trades. Don’t be b e one of these people. Take the time to read each section slowly, deliberately and go over them a few times. You’ll often find a few ideas you didn’t d idn’t catch on the first read. By the time you’re done with this book, you’ll be light years ahead of your trading peers  – most retail traders focu focuss so much on te technical chnical indicators indicators that they don’t reali realize ze the wealth of information that candlesticks alone can provide. Congratulations once again for making the right choice.

To Your Trading Success!

 

What’s new in this version? Since this book was first published almost 4 years y ears ago, I’ve had the incredible privilege of communicating with traders just like you, from all over the world. I’ve talked to you guys from the United States, Malaysia, Australia, United United Kingdom, Indonesia, Canada, South Africa, New Zealand, Italy, India, Germany, Brazil, Netherlands, Belgium, France, Russia, Poland, Mongolia, just to name a few!  Your questions and comments have helped me be better tter understand understand the challenge challengess you face in the markets, and deepened my understanding of candlesticks and how to interpret them. This new version of Candlesticks Made Easy  would  would never have happened without your ongoing support, so thank you for you for helping me share this passion with the world. Based on the feedback received, I’ve revamped the whole structure of this book. Some unnecessary unnecessar y portions have been removed, and a number of completely new sections have been added. Notably, I’ll be introducing a more coherent “1-2-3 step” approach to interpreting candlesticks, as well as adding on a section about the dynamic psychology behind the candlesticks you see on a price chart.  Also, we’ll be spending spending some time learning how to identify pr price ice randomn randomness, ess, as not al alll candlestick signals are created equal. This is the one common topic I’ve found most traders to be struggling with, so I’ll be addressing that thoroughly. Please keep your questions and comments coming in – they help me get a clearer picture of how I can better transfer my knowledge about trading, to you. This book will keep evolving based on your feedback.

Thank you for your support.

 

Introduction Being a trader is very much like being a detective. Imagine you're a detective who's trying to solve a murder case... what's the first thing you'll need to do?   You'll have to conduct a genera generall survey of the cr crime ime scene scene,, question all wi witnesses tnesses and try to determine the motives of the possible p ossible suspects. This will give you a general idea of how, why, when, and by whom the crime was committed.  But that's not enough to solve the case, is it? ‘General ideas’ are not enough... You'll need to gather evidence to support your claims!   And so you zoom-in zoom-in on th the e details of the crime scene scene:: you dust for fin fingerprints, gerprints, car carry ry out DNA testing, and go through the video recordings before, during and after the crime.  All these pieces of of evidence ne need ed to point to the same suspect in o order rder for him him/her /her to be convicted of the crime. Without the evidence, you can't solve the case.

So what has all this got to do with Forex trading?   You see, profitable profitable trading invo involves lves this exa exact ct same proce process... ss... You'll fi first rst need to sstep tep back and take a look at the big picture: What's the current market trend? Where are the major support and resistance levels? What's the general outlook for the U.S. Dollar over the next two months?  These are all questions that will give you a rough idea of where the market is headed. But just like in the 'detective' example, this informatio information n alone should not be convincing enough for you to take any action... you'll need to zoom-in on the candlestick activity to confirm your suspicions before you can place a high win-probability win-probability trade. Candlestick analysis is how you gather evidence to support your trading decisions. And   And once you understand how to properly interpret candlesticks, you'll be able to enter and exit the market with pinpoint accuracy for maximum profits!

 

Overview Here are the 4 main candlestick concepts we'll be covering:

1. Solitary candlesticks We’ll begin by first discussing candlesticks that have significance on their own. These are single candles that convey a particular message message about what’s happening in the market. 

2. Relative candlesticks Next, we’ll look at how neighboring candles can give you a better picture of the recent market price action. If a single candlestick can reliably predict future market direction, direction, imagine how powerful a cluster of candlesticks can be! In this section I’ll teach you how to read and understand relative candlesticks so you won’t have to memorize any candlestick patterns. 

3. Significant price formations Once you’ve understood the underlying mechanics behind relative candlestick analysis, it’s time to expand our scope to even more significant formations; this time in relation to crucial price levels in the market. 

4. Explosive formations The last of the core concepts, this section will provide you with 2 incredibly reliable candle formations that have time and time again provided me with consistent consistent profits. These formations aren’t 100% accurate, but they’re pretty darn close! You’ve to see it to believe it.  Lastly, I’ll wrap up with a couple of key principles p rinciples so you’ll get a complete picture of how to execute your trades with pinpoint accuracy.

 

Solitary Candlesticks Just in case you’re new to candlesticks, here’s a quick introduction… What are candlesticks candlesticks? ? Candlesticks are graphical representations of market price movements within a specified time period. A candlestick may represent price movement that occurred in the last 5 minutes; 15 minutes; 30 minutes; 1 hour; 4 hours; 1 day; 1 week; or 1 month for example. This is what a candlestick looks like. The thick portion is known as the real body, and the thin parts are known as the shadow. Got it? Now let's now see what the real body and shadow can tell us about how market prices have moved.

Remember that each candlestick represents a specific time period?

Let's assume the the candlestick to the right represents price movement in a 1 hour period.

The 'open' would be the market price p rice at the beginning of the 1 hour. The 'close' is the market price at the end of the 1 hour. The 'high' and 'low' are the highest and lowest prices that were traded within that 1 hour, respectively.

 You may have wondered wondered at this point why the ca candlestick ndlestick is green in color. Most trading platforms today will allow you the option to change the color of the candlesticks you green  see on your charts, so it doesn't really matter. For the rest of this book, let's use green 

b earish candlestick. to represent a bullish candlestick, and red  red to represent a bearish

 

  What’s a bullish/ bearish candlestick?

 A bullish candlestick candlestick represents represents market price pricess that are moving moving up. If you llook ook back at the 1 hour candlestick (in the previous page), you'll see that the 'close' (end) price is higher than the 'open' (beginning) price. This means that in that 1 hour, the market has moved from the 'open' price, up to the 'close' price.  And now here's here's a bearish candlestick: candlestick:

Notice that a bearish candlestick is the opposite of a bullish candlestick: it shows how prices have moved down within the time frame that the t he candlestick represents. Bearish candlesticks are usually represented by the color red.

Special candlesticks  candlesticks  Occasionally, Occasionall y, you'll come across candlesticks that have no shadows, or have no real body. These are very special candlesticks that can provide you with crucial informa information tion about here market price may be headed. I will discuss more about these special candlesticks next.

 

The Power of Momentum

This is potentially the most important concept in candlestick analysis. If there's only one thing you can learn from candlestick analysis, I recommend that you learn about how to read momentum.

So what is momentum? Momentum is essentially a measure of how strong price movement is.

Try to answer this question: Which of these candlesticks show a stronger upward price movement?  movement?  

Using what you've just learned about how to read candlesticks, take a moment to think about your answer.

Turn to the next page p age when you've decided on your answer...

 

Did you guess candlestick 2? If you did, good job!

So why does candlestick 2 show a stronger upward momentum?

 Although both candlesticks candlesticks have the same high-low high-low price ran range, ge, candlestick 2 sh shows ows no hesitation in upward price movement. movement. Also, candlestick 2 shows a higher closing price.. price Here's an example of how prices moved:

Can you see how candlestick 2 shows the price moving straight up? This is an indication of a strong upward momentum.

Candlestick 2 is often called a bullish shaven candle. candle. The opposite of a bullish shaven candle is called a bearish b earish shaven candle. (duh)

But how does understanding price momentum help you make money in trading? Let's now look at an example of how shaven candles can help...

 

  Here, we see a bearish shaven candle that is soon followed by a further drop in prices. If you sold the market after seeing this bearish shaven candle, you would have made money!

Now, if you open up your trading charts and take a look, you'll be able to find many similar instances where a bearish (or bullish) shaven candle is usually followed by a subsequent drop (or rise) in prices.

Go ahead and check out your trading charts now. It's important that you're convinced of the strong influence of shaven candlesticks on future price direction.

...

Turn over the page when you're ready...

 

 All right Chris, I'm convinced. But why are shaven candles so accurate in predicting the direction of future prices?

The answer is because shaven candles indicate strong momentum in price movements. In the above bearish shaven example, there was no shadow because the sellers in the market completely overwhelmed overwhelmed the buyers; the buyers couldn't drive the price up at all! The sellers were too strong.

 And once the buyers buyers are tempor temporarily arily defeate defeated, d, prices will co continue ntinue to free free-fall -fall until the buyers can regain their strength and start pushing prices back up again.

Wow that's great! Are shaven candles 100% accurate a ccurate in predicting future price movements? Nope. Not a chance. If it did then all traders would be rich by now. Haha... nice try.

Sometimes, shaven candles are immediately followed by prices moving in the opp opposite osite direction of them... as is often the case during the release of certain economic news announcements. Important: All Important:  All types of technical analysis (including candlestick analysis) analysis) is likely to be ineffective during high-impact news releases, such as the Non Farm Payroll report on the first Friday of every month. Do not, I repeat, do not trade d during uring these periods.

 

Shaven candles aren’t the only indicators of strong momentum in the market. There are several other ways to identify the strength of market price movements. However, shaven candles are one of the most reliable indicators that I've come across.

To summarize.. summarize....

I hope you now have a good idea of how momentum works... the main point you should remember is that momentum is like throwing a stone: the stronger the initial thrust, the further the stone travels. In this sense, the larger a shaven candle, the more likely (and further) prices will continue move in the direction of that candle.

However, you should remember to ignore any shaven candles on the charts during times when important economic news is announced.

BUT!  As with all other other trading in indicators dicators and anal analysis ysis tools tools,, you should n never, ever, ever, e ever ver (EVER) rely solely on candlestick analysis to trade. This means that you shouldn't just blindly enter into a BUY trade the moment you see a bullish shaven candle.

Candlestick analysis is meant only to be one criteria out of the many trading criteria you should have in your own trading system.

Use candlestick analysis together with your technical indicators (or trading method). If you see a bullish shaven candle, but your other technical indicators tell you not to enter into a BUY trade, then please p lease don't buy! In the next section, I'll discuss about markets with weakening momentum...

 

When Momentum Is Lost

When momentum is strong in the market, it's a good time to enter into a trade. But when do you exit the trade?

The answer is when that momentum begins to slow down. And as you might have guessed, the candlestick that best shows the lack of momentum is the Doji:

On the trading charts, a Doji looks like a cross because the open price is the same as the close price; therefore, this candlestick has no real body at all.

 A Doji can represent represent eithe eitherr one of two things: 1. Buyers and sellers are equally strong 2. Indecision in the market

1.  Buyers and sellers are equally strong

When the buyers and sellers of the market are fiercely fighting each other, prices may not fluctuate much. This is because both sides are equally strong at that point in time, and are caught in a deadlock. However, the moment one of the sides starts to lose strength, the other side will usually push prices strongly in their direction.

2. Indecision in the market

Sometimes when the market is behaving b ehaving unpredictably, traders in the market don't know whether to buy or sell. This results in a Doji candlestick on the charts because neither buyers nor sellers are strong... they're both weak! This is the opposite of the (above) point 1 when both sides are exerting strong buying/selling pressure.

 

How to trade using a Doji candlestick

Many Forex books and websites claim that a Doji candlestick indicates a change in market direction. Now that you understand the reasons for the formation of a Doji, do you agree with what these books and websites say?

Not necessarily, right? Whether or not a Doji indicates a possible change in market direction depends on the reason for the formation of the Doji. For example, indecision in the market is unlikely to cause a change in market direction! Weak buyers/sellers will not be able to push price in any direction at all.

Summary

By now, you should know that long shaven candles signify strong price momentum in the market, and that strong momentum is a good indicator of the direction of future price movements.

 You also now know that a good time to ex exit it your 'in-the-mo 'in-the-money' ney' trades is w when hen loss of momentum is observed in the market. A Doji signifies a loss in momentum, although this does not mean that prices will definitely reverse in the opposite direction. Never try to predict trend reversals (and enter the market) based on a single Doji candlestick!

One more thing about the Doji before we move on – you may have noticed that the  ‘hammer’ and and ‘hanging man’ candlesticks have similar similar characteristics characteristics to iit: t:

So for trading practical purposes, just treat them in the same way you’d treat a Doji! 

 

Let’s move on to the next important candle characteri characteristic: stic: Long shadows. 

Long shadows  shadows   A long top shadow shadow means tha thatt the buyers buyers in  in the market tried to push prices up, but the sellers were sellers  were strong enough to push prices back down again.   A long bottom shadow means means that the sellers sellers in  in the market tried to push prices down, but the buyers buyers were  were strong enough to push prices back up again.  Long shadows represent buyer/selle buyer/sellerr rejection. Here’s an example: We entered into a Buy trade a few days ago, and the market has been on an uptrend... we're currently in-the-mone in-the-money! y!  Suddenly, we see a long top shadow form right at the top of the market: 

 

 

Phew! Did you see how fast the price dropped? d ropped? Thank goodness we took our profits before this happened!   At this point you might might like to open up your trading char charts ts and see if you can find more of such examples; I’m sure you’ll see many similar setups. 

 As you can see, long long shadows ser serve ve as an indic indicator ator of the co comparative mparative str strengths engths between the buyers and the sellers. They indicate a high chance of market prices going in the opposite direction (of the shadow). One more thing: the longer the shadow, the more likely prices will move in the opposite direction of the shadow.  That’s about all there is to it. Pretty simple, huh? 

Let's talk about multiple shadows next...

 

Multiple shadows  Unlike a single long shadow, the presence of multiple shadows usually indicates indicates the weakening  of support or resistance levels. weakening levels. While a single long shadow indicates shadow indicates a likelihood of prices moving in the opposite direction of the shadow, a cluster of multiple shadows indicate shadows indicate that prices are likely to move in the same direction as the shadows.  Confused? Let’s look at an example…

Here, we see multiple shadows trying to penetrate a support level. Also note that the closing prices are getting lower and lower. What this means is that the sellers are aggressively testing the strength of the support level...  level... 

 

In instances like this, the buyers are looking weak! I would expect the sellers to overpower the buyers soon… 

 

Reverse Rejection 

Rejection candles do not always signal a reversal, so you’ll need to know how to tell when a rejection has failed, and how to react accordingly.

The best way to understand this is through an example:

Here, we see the market moving down. The latest candle shows a long bottom shadow, indicating seller rejection. This may be a good time to enter a BUY trade.

Let’s see what happens next…

 

  Three candles later, we see that prices have NOT continued to move up.

This means that the rejection signal has failed .

When this happens, prices are highly likely to keep moving in the same same direction  direction (in this case, down).

It would thus be a good idea to exit any BUY trades, and SELL instead.

What happened next?

 

  Prices continue to drop and a nice profit is made.

 As a rule of of thumb, rever reverse se rejection rejection occurs whe when n prices close halfway (or more) of the long shadow of the rejection candle.

This is a simple but deadly effective method for minimizing losses and getting onto the right side of the market. 

 

The important thing here is to understand the reason behind the concepts you’ve just learned. This may take some time to get used to, but keep at it and it will soon become easily to you.   All right! This wraps up this section. section. Let’s no now w move on to the more e exiting xiting part… Relative Candlesticks! 

Relative Candlesticks  A cluster of candles candles can give you a good underst understanding anding of the context context of price a action. ction.  Allow me to illustrate illustrate thi thiss with a questio question: n:

If we look at this single candlestick, we might say that the market is bullish. However, if we take a step back and look at the candle before b efore it… 

 

…then we might come to a completely different conclusion. conclusion. This is essentially what relative candlestick analysis is about. It shows you how current prices are moving in relation to past price movements.  As shown in this example, a sin single gle bullish can candle dle doesn’t mean mean that the m market arket is necessarily necessaril y bullish. To make a better judgment, you’ll need to take a look at the bigger picture… and that’s why single candlestick analysis is not enough – you’ll need to learn about relative candlestick analysis too. 

Relative Momentum Remember how we talked about momentum before? The same principle can be applied to relative candle analysis. analysis. Here’s how... Let’s assume we see a bullish shaven candle and enter a BUY trade: 

 

 

Now, notice how the uptrend is becoming less and less steep. Prices are still going up, but at a slower pace.

 

 Also notice how how the bullish candles became sshorter. horter. This is an indication of the slowing down of momentum. momentum. Now is a good time to consider exiting the trade and taking profits.

…next, we see what looks like the beginning of a price reversal.

If we didn’t notice the slowing down of momentum and exited our trade, we would have a lost a big portion of our profits by now!

Cool! Is this 100% accurate at predicting price reversals?  Nope! The slowing down of price momentum is not a guarantee that the market is going to reverse. It only indicates a higher chance of prices moving in a different direction. Sometimes, the prices will reverse; and sometimes the prices will continue to shoot up. Of course, it’s equally likely for prices to start ranging too. It’s up to you to decide whether to exit the market in such a situation. It depends on your risk appetite and what your technical indicators are telling you. 

 

In general, slowing momentum is an indication that the buyers (or sellers) are losing ground to the sellers (or buyers), and a change in price direction may be coming.

Reading Candle Patterns (without memorizing)  If you’ve been following me so far, this should be easy for you to understand.  What does this situation tell you about market prices? 

Take a moment to think about your answer based on what you’ve learned so far. Where do you think prices are not  likely  likely to go after this?  Did you guess that prices are not  likely  likely to move down?? If you did, good job!  Let’s examine why:  Candles 1 and 2 indicate that the market is on a downtrend. But although candle 1 shows strong downward momentum, we can see a slowing down of this momentum in candle 2 (candle 2 has a smaller body).   Next, we see candle 3 is showing strong upward momentum, as it completely covers the body of candle 2. This is an indication of the weakness of sellers in the market, as the buyers completely overwhelm them. 

 

Candles 2 and 3 form a candlestick pattern called the ‘engulfing’ pattern. You don’t have to memorize this candle pattern... you just have to understand how it works, and you’ll be fine! There are also many other candle patterns you can memorize, but with these reading techniques you’ve just learned, you won’t need to. Everything you’ll need to know k now is already in your head!

Anchor Candles Occasionally, prices will reverse without forming a clear reversal pattern. In these situations, how do we know whether a counter-trend move is going to be a temporary retracement, or a full-blown reversal?

Here’s the trick.  You’ll first have have to identi identify fy what I call an ‘‘Anchor’ Anchor’ candlestick.

It’s basically a candlestick that has a longer body than the surrounding candlesticks.

Example:

 

  Example:

There’s no scientific rule to determine an Anchor candlestick. Simply use your judgment  – they’re pretty easy to find.

If you’re having problems looking for one, it probably isn’t there.

When a candlestick closes past the opening price of the Anchor candle, a reversal is likely to happen.

If not, it’s just a retracement.

Let’s take a look at what I mean…

 

  Here, we see prices moving up, forming an Anchor candlestick.

Two candlesticks later, the market closed past the opening price of the Anchor, and the market consequently reversed.

Here’s another example:

 

 Another example: example:

The market moved up with a strong anchor, and then dropped back down again. This looks  like  like a reversal… but is it really?

Let’s see what happened next:

 Ah… it turned out out to be a strong strong retracem retracement! ent! Could we have known it was was probably a retracementt beforehand? Yes! If you look closely, prices did not close past the opening retracemen price of the Anchor candlestick!

 

  One more example:

This is pretty straight forward. Prices dropped significantly, forming an obvious Anchor candle.

Two candles later, the market closed past the opening price of the Anchor, confirming the reversal. Subsequently, prices continued in the direction of the reversa reversal. l.

Reverse Candlestick Psychology This is a powerful method of identifying where a ready pool of buyers and sellers are in the market.

Did you know that a single candlestick (on its own) is by its nature, an area of support/resistance?   support/resistance?

 

Let’s take the example of a bull candle:

 A bull candle tells us us there are a larger volum volume e of buyers than sel sellers lers (nothin (nothing g new here). But this information is based on something that had already happened .

How does this help us make trading decisions in the future ? 

The answer:

 A bull candle tells us at what what price the there re is a rea ready dy pool of se sellers llers in the future future   Does this make sense?

OK, imagine…

 You’ve just entered entered a BUY tra trade, de, and prices star startt moving up – that’s that’s great! Your Your trade is making money.

Soon, however, you notice that prices are starting to move back down again… your position is still making money, but the market is now moving dangerously close to your trade entry point. What would you do?

If you’re like most traders, you’ll hang on to the trade… and wait for it to move back up again!

But what happens when prices continue to move even closer to your entry point? What do you think most traders would do then?

 

They will attempt to get out of the trade at breakeven breakeven –  – most traders traders would have already moved their stop loss to breakeven, or if not, will manually get out of their BUY trades as soon as the market moves to the breakeven price.

 And so, all the traders wh who o entered a BU BUY Y trade alo along ng this bull candle are now looking to SELL to close the trade trade..

 A bull candle thus represents the range of prices  where  where the previous buyers are now looking to sell to close their previous (buy) trade.

 A bull candle represents represents the price ra range nge where there are a bunch of traders looking to SELL.

 A bear candle candle represents represents the price range wher where e there ar are e a bunch of tra traders ders looking to BUY.

On a practical level though, it would be insane to apply this concept to every candlestick on the trading chart.

 A much better (and (and more e effective) ffective) way to use this concept is in in the situa situation tion where there are a series of strong bull/bear candles.

Here’s an example:

 

  Prices have been falling rapidly with a series of consecutive bearish candlesticks. This is where you have a large pull of traders waiting to BUY to close their trade positions. p ositions.

The latest (bullish) candlestick shows that the buyers are now attempting to push prices up. If they manage to push the market up high enough, the previous sellers will exit their trades (becoming buyers too).

When this happens, the market will shoot up quickly, like a row of dominos as each closing trade pushes the market even higher:

 

  This simple but rarely applied knowledge will aid you greatly in deciding if you should keep any existing trades open, or if you should consider opening a new trade to take advantage of such a situation.

(By the way, did you also notice the bearish Anchor candle? Did you see how a close above its opening price p rice signaled a reversal?)

Remember: although I’m describing each concept here separately, in practice all of them work should be applied at the same time.

 

How Reversal Patterns Work Reversal candlestick psychology is one of the reasons why reversal pattern patternss are such effective predictors of price reversals.

Here’s an example:

In the above diagram, the bullish b ullish engulfing pattern has formed and the market is moving up. All the previous sellers (from the bear candlestick) are now at a paper loss, and will be looking to exit their positions (at breakeven, or so they hope) with BUY trades, forming an area of support .

If prices move back down into the range of the bearish candlestick body, you can bet that the previous sellers will quickly BUY to close their trades, pushing the market price back up.

 

  Similarly, after a bearish engulfing pattern has formed and prices continue to move down, the previous buyers (from the bull candlestick) are suffering a paper loss and will be looking to exit their trades at breakeven with SELL trades, forming an area of resistance .

If prices move back up into the range of the bull candlestick body, the previous buyers will immediately exit their positions (with SELL trades), pushing the market price down again.

This is an extremely powerful concept and you will do well to trade according to it.

Take a moment now to ‘digest’ this information.

Re-read this section again if you have to. If you don’t understand what’s going on here, the next section will probably confuse you.

 

Trick candle pattern: Profit taking   Before we move on, it’s important that you understand the implications of profit taking in the market. When traders don’t take into account profit taking behavior, they’ll often be tricked into placing low winning-probability trades.  Here’s what I mean:

In the candle formation to the right, we might be fooled into thinking that this is the start of a price reversal – after all, we can see the strong momentum of the bear candle (not to mention a bearish engulfing pattern), right? But in this case, a large bear candle doesn’t necessarily mean that the sellers are getting stronger… 

Due to the strong upward trend of the first three bull candles, we must now take into consideration the possibility of buyers who are now taking their profits (i.e. buyers with in-the-money in-the-mone y trades who exit their positions).  If you noticed, the close price of the last bear candle did not go lower than the open price of the first bull candle (which is… you guessed it! An Anchor candle!)

This means it’s entirely possible for most of the selling activity (at this point) to be coming from the buyers who are exiting their positions. We’ll need to see more commitment from the sellers (who aren’t the previous buyers) before we can say that prices are likely to reverse.  A stronger signal signal for a price price reversal w would ould be this:  See how the close price for the last bear candle is lower than the open price of the anchor candle? This tells us that it’s likely that there are more more sellers  sellers in the market than just the previous buyers. 

 

  How will I know for sure when ‘profit taking’ is happening?  Unfortunately, Unfortunate ly, you can't know for sure. You’ll just have to consider other factors that can increase your chances of making a well-infor well-informed med guess. For example, traders are more likely to take their profits at prominent support/resistance levels (we’ll talk more about this later). 

Reading Price Action If you’re following me so far, you’ve pretty p retty much learned the steps to understand price action.

The 4 steps of reading Price Action: 1.  Observing how prices moved in the past 2.  Observing how prices are moving now 3.  Predicting where prices are not  likely  likely to go next 4.  Predicting the possibilities of where prices may go next

The first 2 steps are about accessing what the market has already done. Based on your interpretation interpretatio n of how p prices rices have moved, you can then move on to step 3.

If the bullish momentum is strong, you know that prices are unlikely to move down in the immediate future. If you see a close below the opening price of a bullish Anchor candle, you know that prices are unlikely to keep moving up in the immedia immediately tely future. So all you need to do now (step 4) is to take, or manage your trades accordingly.

 

Time for an exercise! 

Now let’s go through a quick analysis example to see if you’re on the right track:  Recent price action indicates a mostly ranging market. There’s no obvious buy or sell signal here (in the chart below). 

Can you tell where the latest anchor candle is? (hint: it’s a bull candle) So far, prices have not closed below the Anchor candle, so we must be prepared for the possibility of a continuati continuation on of the up-move.

Let’s see what happened next... 

 

  Now, we see a huge bear candle. Strong bearish momentum? Check. Close below the  Anchor candle? candle? Check. This indicates a good SELL signal.

 

 Yes! If we took the SELL trade, we we would be in in-the-mone -the-money y now! But we sh should ould be careful because the downward momentum is slowing down… We know that the downward d ownward momentu momentum m is slowing down because: 1. The bearish candles are getting smaller.  2. A bullish candle approximately the same size as the previous bearish candle is formed.

This indicates a lack of momentum in the market because neither the buyers nor sellers are strong enough to push prices further in their direction. This might be a good time to take our profits in case the buyers start to take over and push prices back up. However, if (for whatever reason) we think that prices might keep falling, we can just place a stop order to secure some of our profits.

Let’s see what happens next… 

 

  It seems that prices continued to go up for a little bit, but now the upward momentum is getting weaker. Prices might just come down again!

*Important note: Weakening momentum is not not a  a good trade entry signal. It only indicates that the current trend is ending, so it’s only useful as a trade exit exit signal.  signal. Weakening momentum does not tell you where prices are likely to go – so don’t enter into a trade just because you see weakening momentum. Prices are just as likely to go up or down afterwards. 

Right, let’s go ahead and see what happens next! 

 

 

Prices went down again, but we can also see the subsequent loss of downward momentum (smaller bearish candles).   And in the last candle, candle, we see th the e buyers coming in with a str strong ong bullish m momentum. omentum. So will prices go up next? (hint: where’s the latest Anchor candle?)

Let’s take a look… 

 

   As you can see, the market wa wass far from closing closing above the o opening pening price of th the e Anchor candle. So although we didn’t entirely expect prices to immedia immediately tely drop down again (due to the strong bull candle), we knew that prices would not necessarily continue to move up either! We’ve just identified a ‘random area’ on the chart – when you get conflicting signals and prices don’t show any particular likelihood of moving up or  down.  down.  During these periods prices tend to move randomly so we shouldn’t be looking to place a trade

Practice identifying these areas and be wise enough to stay OUT of the market.  Let’s see what happens next… 

 

 

Interesting… prices came down for a bit, but soon climbed straight up. This is completely random movement! Traders who try to predict market prices during this period will be in for a frustrating ride…  Notice the market continued to move up after prices closed above Anchor 2, and subsequently Anchor 1.   And at the latest candle, candle, we can ssee ee a long top sh shadow. adow. If we had taken eithe eitherr one of the BUY trades, now may be a good time to exit.

 Are prices are going to go back down? Let’s find out… 

 

  …and yes, prices did go down. Can you see how the bearish candles closed below each bullish Anchor candle? This indicates that the market is likely to keep moving down.

I could go on with this analysis forever… but let’s just stop here, shall we? I think you get the idea.  As you can see, candlestick candlestick ana analysis lysis is incre incredibly dibly helpful in pre predicting dicting shortshort-term term future market trends. For best results, these concepts should be applied on the 1 hour time frame and above. Remember though, candlestick analysis is not 100% accurate. No single analysis tool is.  Always protect your your capital with well placed sstop top orders, just in case. Let’s now proceed to the next section!

 

Significant Price Formations Now that we’ve learned how to read clusters of candlesticks, let’s apply this to an even wider scope: support and resistance levels. 

While it’s beyond the scope of this book to examine support/resistanc support/resistance e levels in detail, here’s how they generally work:   A support level level is a price llevel evel at which bu buyers yers ar are e expected tto o enter th the e market.  It’s an arbitrary line indicating the price(s) that the market sellers are unable to push p ush below. Here’s an example of a support line: 

Can you see how prices p rices were unable to penetrate below the yellow line? In this chart, the yellow circles indicate the times when the sellers tried to push prices further down. However, they were unsuccessful and so we say that t hat the yellow line has become a support level.  What about resistance levels?

 

Basically, a resistance level is the opposite of a support level. Simple, eh?   When support and resistance levels are almost parallel to each other, we call them a channel::  channel

 As you can see, market market price pricess were unable to break through through either side sidess of the channel. channel. 

What do support/resistance levels have to do with candlestick analysis?  When there is a congruence congruence of  of candlestick analysis and support/resistance, you have a better chance of entering into a high winning-probability winning-probability trade. For example, when market prices hit the resistance level with a long top shadow, it might be a good g ood idea to consider a Sell trade. This is because resistance levels and long top shadows both indicate that prices are likely to go down. Both analysis tools are telling you the same thing.  In general, the more analysis tools are in congruence about where prices are headed, the better. 

 

Let’s now take a look at some other important support/resista support/resistance nce concepts… 

Double Top/ Double Bottom  This formation occurs when prices attempt to break a support/resistance line twice twice.. It typically forms at market bottoms. Here is what a double bottom looks like:  Can you see how prices first hit the support level, went up for a bit, and came back down to re-test the support level again before moving back up? Double bottoms/tops are reliable indicators of price reversals.

Triple Top / Triple Bottom  This is very much the same as double tops/bottoms, except that the support/resistance support/resistanc e line is tested 3 times, instead of just 2.  And because these support/resistan support/resistance ce levels have not been broken despite 3 separate attempts, they are considered to be stronger resistance/support levels.

 

Trading Breakouts Breakouts occur when prices close past p ast a support/res support/resistance istance level:

Now I’m going to reveal to you one of the biggest secrets of how to properly trade breakouts. But before you can appreciate the beauty of this trading technique, you’ll first need to understand how most people typically (and wrongly) trade breakouts. Usually, traders will place a pending BUY or SELL order 1-5 pips below a support level (or above a resistance level) to catch the breakout as it happens. While this may seem like a logical thing to do, it’s actually a risky way to trade. Why? This is because explosions are periods of time where there is a lot of emotional trading in the market.

 

What I mean by “emotional trading” is that there will be many traders who are allowing fear and greed to guide their trading actions… and it is d during uring these times that the institutional traders traders (i.e.. the market sharks) like to prey on such behavior. I won’t go into too much detail regarding this because frankly, the only thing you’d need to know is not to trade on the initial break above or below a support/resistance level.

Remember: Don’t trade on the initial breakout.

So how do we properly trade breakouts?  breakouts? 

The trick here is to first let the emotional trading subside, and wait for the market to settle down and THEN tell you whether the bulls or bears are taking over. Here’s how to trade on an explosion: below we see a channel breakout to the downside (on a 1-hour chart):

 

 At this point, we’ll we’ll wait fo forr the candle to fully form ((i.e. i.e. wait till the hour is u up) p) before placing our trade. Once the explosion candle has completely formed and is shown to be a valid breakout (i.e. the candle does not close back b ack above the support line), we’ll place a pending trade orders as such:

  Pending SELL order: 5 order: 5 pips below the ‘low’ of the explosion candle

•

  Stop Loss order: At order: At half the body of the explosion candle

•

Like this:

 

   And of course… we make mone money! y! :D This is how you should trade breakouts. b reakouts. The fundamental idea behind this technique is to first LET the market tell us that the breakout is a valid one. Many other traders will be greedy and want to trade on the explosion immediately as it happens… and those are the traders that that get eaten up by the sharks.

 

Summary Generally, you should be careful when prices are heading towards prominent support/resistance levels. Try to enter into a trade only when both both candlestick  candlestick analysis and the support/resi support/resistance stance levels complement each other. For example, if you see a large bullish shaven candle hit a strong resistance level, don’t enter a BUY trade… it’s not a good idea to do that! Likewise, if prices close below a bullish Anchor candle at a support level, don’t enter into a trade either!  When prices are nearing a support level, it’s a better idea to wait for a loss of downward momentum and/or a close above a bearish Anchor candle before you consider a BUY trade.  And if you see a breakout below a support leve levell that clo closes ses below a bull bullish ish Anchor candle, you’ve got a high win-probabilit win-probability y SELL trade setup! If you understand these examples, you’re doing excellent! If not, please re-read this book until you can picture these examples in your head. It gets easier with practice.

 And that concludes this section… …phew!

☺ 

In the next section, I’ll show you a special, “explosive” trading pattern!

 

Explosive Formations Imagine that you’re holding a metal spring between your index finger and thumb. As you press the spring together, it becomes b ecomes harder and harder to keep it compressed. When you release either your index finger or thumb, the spring will jump out violently in the direction of where pressure was released. 

 Very amusing, Chris. But what’s this got to do with Forex trading?  Let me share with you my little secret…  This is exactly how some of the most profitable candle formations work.   Here’s an example of a triangle formation:   It’s called a triangle because when you draw the support and resistance lines, you get the shape of a triangle… 

 

 

…like this! 

For there to be a valid triangle formation, prices must hit the support and resistance lines at least 4 times. times. 

In this example, we see that prices actually hit the support and resistance lines 5 times. 

 All right, back to analyzing the triangle…  Can you see how prices fluctuated less and less over time inside inside  the triangle?  triangle?  This indicates a buildup of pressure, much like in the metal spring example I mentioned earlier. 

 

 And when either the resistance resistance or support le level vel is broken, prices will shoot shoot out in th the e direction of the break.  That's it. Pretty simple, huh? 

*Warning*:: You’ll have to be careful about where you place your stop orders when *Warning* you trade on these ‘explosions’. After support/resistance support/resistance is broken, prices will occasionally fall back a little before continuing in the direction of the break.  In the above example, we see that prices did fall back into the triangle briefly, before continuing with the uptrend. Many traders’ stop loss orders would have been triggered there, since most people like to place their stop orders just above or below support/resistance support/resistanc e lines. If you’re trading on a triangle ‘explosion’, make sure your stop loss allowances are not too tight! 

 

What About Profit Targets? Profit targets are a little tougher to estimate for maximum profits... But here are four guidelines you may wish to follow when placing your profit targets:

   At least 2 times times your stop lo loss ss allowan allowance ce

•

   At a prominent prominent support/re support/resistance sistance level

•

   At a round number number (ex. 1.5 1.5600, 600, 109.00 etc)

•

  When you see a slowing down of momentum

•

 And… That’s it!   You now have two simple but incredibly power powerful ful concepts to be trading with. These These formations can be found in almost all time frames, so you’ll come across them pretty often.  Keep in mind that the longer the time-frame these formations are found in, the more significant (and reliable) they are. For example, a triangle breakout on the daily chart is going to net you more pips than a triangle breakout on a 1-hour chart.   Also, be careful careful when using these these techniques on charts that a are re on a lo lower wer time fr frame ame than the 1-hour chart (i.e. 5-minute chart, 15-minute chart etc). The stop loss allowances will be quite small and may get prematurel prematurely y hit, especially during periods of news announcem announcements. ents.

 

The Time Frame Principle Here’s one trading principle I’d like you to pay attention to...

  To the right are two 1-hour candles.

Try to answer the question as best you can. 

Of course, this is a trick question… well, sort of. The point I’m trying to make is that sometimes you can’t tell how bullish or bearish a candle is simply by looking at a single time frame. Let’s now take a closer look at these 1-hour candles by zooming in to their respective 15-minute time frames… 

Take a moment to compare candles A and B this time:  

 

 

 Although they look look exactly the same in the 1-hour tim time e frame, whe when n we look at the 15 minute chart they paint a completely different picture from each other!  In this case, candle A is obviously more bullish.  Can you see the importance of ‘zooming in’ to the shorter time frames? Shorter time frames can provide you with details that the longer time frames can’t.  A good habit to cultivate when when trading is to occasionall occasionally y look at the sshorter horter time frames to support your trading decisions.

Never Forget To… One last thing you’ll need to remember: 

 Always wait for the candle to complete its formation before placing your trade 

 

Here’s what I mean…  Let’s imagine we see a break below a channel on the 1-hour chart.

The time now is 4.30pm 

Many traders will get excited and scramble to enter into a Sell trade. In their excitement, they forget that the last candle is not completely formed yet!

 

The time is now 5.00pm 

 And here’s what what happens when th the e hour is up and and the candle iiss fully forme formed d – prices shot right back up into the channel again. This was a false break!  If those earlier traders had waited for the hour to be up before trading, they wouldn’t have been caught in such an unpleasant situation. Don’t be like those poor traders… learn how to protect yourself against these unnecessary unnecessar y losses!

Rule Of Thumb  Only trade breakouts after a candle closes above a resistance level, or below a support level. 

 

Don’t trade on breakout candles before they have completely formed.  This is the reason why I advise traders never to trade on the initial breakou breakoutt of a triangle or channel formation.

Go Make Some Money! Congratulations on making it this far! 

The concepts you’ve learned have been carefully chosen and explained to give g ive you the best chance of making significant profits… so please follow them carefully!

“What about all the other candlestick formations?”  I know, I know… you’ve probably heard about the ‘head and shoulders’ or some other more commonly-known candlestick formation. formation... .. 

The reason why I didn't discuss them here is because you’ll get to the same conclusion  just by following the concepts covered covered in this boo book. k. For example example,, a head and and shoulders pattern essentially signals a loss of upward momentum (possibly leading to a close below an Anchor candle), which would lead you to close any profitable BUY trades, and consider taking a SELL trade.

So what you’ve learned here is the underlying reasons behind ALL candlestick formations – so you won’t need to memorize them, and still get to the same conclusion.

Now THAT’S an education worth having.

 

Thanks For Reading!  Thank you so much for taking the time to read and understand this book. I hope you’ve gained some valuable insights that will give your trading profitsa big boost!

Take care, and I’ll talk to you soon!

Best wishes,

 

A Note From Chris

A lot has changed since my first e-book, Candlesticks Made Easy  was  was published in 2008 (6 years ago!).

At the time, global market volatility shot up to all-time highs as the financial world reeled in the wake of the U.S. sub-prime crisis.

And now in 2014, volatility levels have retreated back to near record low levels never seen since 2007.

The chart below (VIX) illustrates i llustrates the differing scales of volatility between the periods 2008 - 2012, and 2012 - 2014.

At the peak of the crisis, price volatility was 3 - 5 times higher than the volatility levels weÕre seeing now.

Put another way, way, the market volatility is now approximately 75% - 85% lower than it was 5 years ago.

 

  HereÕs the EUR/USD chart comparing the same two periods:

For many traders, itÕs been a roller-coaster ride as financial markets around the world experienced dramatic shifts over the past few years.

In particular, fixed trading systems that worked well in the past suddenly suffered from a long string of losses.

 ÒWhy did my my system stop working?Ó people people asked.

Well, We ll, the thing about fixed systems is that they can only keep working if the nature of the market is fixed. The ÒproblemÓ, so to speak, is that the market never stays the same for long.

This is why, in this book, weÕll focus on the practical philosophies and principles behind trend trading, rather than merely describing a fixed trading system based on technical indicators.

By understanding exactly what  trend  trend trading is and how  it  it works (and why )),,

youÕll be able to keep trading well in the face of changing market circumstances.  

Introduction Successful chefs donÕt follow recipe books. In their head, they already have a deep understanding of each ingredient and what it tastes like when combined with other ingredients.

Put a dish in front of an expert chef, and he can mentally break it down into its components and modify the recipe. And if heÕs really good, he can create an entirely new dish with the same ingredients.

ThatÕs the level of market understanding I want you to attain after going through this book and practising its principles. My goal is for you to be able to look at any price chart, figure out whatÕs going on, and be able to trade it effectively.

You wonÕt be getting cookie-cut theories here, since that wouldnÕt be useful at the practical level. Instead, youÕll be getting the tools to come up with your own answers, based on what the market ÒtellsÓ you. ItÕs this feedback loop that keeps you in touch with the ever-changing ever-changing nature of the market.

Trading systems and styles come and go, and the only thing we can really count on is our ability to reason and think our way through the inevitable changes that will keep happening in the future.

Only by learning (and practising) how to identify and respond to these changes, can we avoid the traps so many others have fallen into, and continue thriving as traders.

In this sense, this book isnÕt about teaching you what  to  to think, but how  to  to

think like a trader trader..

 

 

Note: Not For Beginners

To fully benefit from this book, youÕll need a basic understanding of trading. If you donÕt know what a candlestick, moving average, average, or limit order is, this book is probably too advanced for you right now.

If youÕre new to Forex trading, check out the trading school at the Baby Pips website: babypips.com/school. babypips.com/school. There, you can pick up the basics of Forex trading, and come back here afterwards.

It will also be helpful if you already understand the concepts of momentum, rejection, reverse rejection, and anchor candles (that are covered in Candlesticks Made Easy ). ). I wonÕt be explaining these concepts and will assume

you already know how they work.

Now letÕs get started.

 

Content vs Context When we learn something new, we pick up two aspects about it: the content, and the context.

The content refers to factual information. ItÕs about the what , how  and  and when. This is what most people focus on.

For example, retail traders often rely on indicator-based indicator-based systems for their trading decisions. The indicators supposedly tell them what the market is likely to do in the future and when that might happen. The system then tells them how  they  they should trade that prediction.

ThereÕs no ambiguity involved with the content Ñ the moving average lines have either crossed, or they havenÕt. The Stochastic Oscillator indicator is either in the overbought region, or it isnÕt. There is no grey area.

And since retail traders tend to come from technical/academic technical/academic backgrounds, this is the area they are most comfortable with. They like dealing with precise questions, formulas and answers.

Unfortunately, financial markets (and indeed, human beings) do not operate within these parameters. There is no formula that can predict the aggregate outcome of human actions, especially when greed and fear are involved. involved.

Now what about context ?

Context is all about the why . ItÕs about the meaning we assign to something. ItÕs about the way  we  we look at it. ItÕs the subjective view.

 

 

For example, how would you feel about attending a class on advanced statistics? Some people would rather stab themselves in the eye, while others would pay good money to be there.

And therein lies the defining characteristic characteristic of context : the same information can mean very different things to different people. Two people with the same information can act in opposite ways because they have opposing views of it.

In this sense, two trend traders can take completely different actions at the same point in a price trend.

For example, look at this downtrend:

As a trend trader, what would you do in this situation?  

Would you sell immediately? Or would you wait for a pullback?

Either option could be the right one, depending on your context (view) of trend trading.

Next, we see that prices did not move further down, nor did it make a pullback. Instead, it started to consolidate:

Now in this case, what would you do? Sell, or wait?

 

  Next, we see prices start to move up:

Now what should you do? Sell, wait, or buy?

One trend trader might think that this is the end of the downtrend, and buy in anticipation of prices continuing to move upwards (in a new uptrend).

Another trend trader might think that the market is getting choppy and would prefer to stand on the sidelines.

Yet another trend trader might think that this ÒpullbackÓ a good opportunity to

add on to his short position and enter a new sell trade.

 

So which approach is the correct one?

The thing is, these traders could all  be  be making the right decision.

You see, it depends on the philosophy  behind  behind their trading approach.

It depends on:

¥ How they define a trend ¥ What they think causes prices to move ¥ How they think prices tend to move ¥ Their trading time frame ¥ How they define the end of a trend ¥ Their risk-reward ratio ¥ É among many other considerations

As long as the reasons for the trade are consistent with their trading philosophy, each one of those traders could be doing the ÒrightÓ thing.

So although trend trading has often been talked about as a particular way  of  of trading (that is, in the direction of the trend), in practice that distinction means little. There are simply too many different ways ways to be Ôtrend tradingÕ for there to be any meaning in calling them the same thing.

Thus, what matters is the context  in  in which we view Ôtrend tradingÕ, because that is what will determine whether  weÕll  weÕll enter a trade, where weÕll do so, where weÕll close it, and most importantly, why we choose to make each of

those decisions.

Once you understand the context behind the Practical Trend Trading approach, youÕll naturally know what to do in all market situations.  

 

Trend Trading Philosophy

The essence of trend trading is closely related to the only situation in which traders make money: when the market price moves.

If the market price did not move, trade traders rs would not exist.

In this sense, all traders rely on a price trend. Even counter-trend trade traders rs need a trend in order to trade in the opposite direction of it.

Thus, the only real difference between a trend trader and range trader (or counter-trend trader) trader) is how long they expect the current trend to continue.

A trend trader might expect the trend to continue indefinitely (until it proves otherwise), while a range trader might expect the trend to reverse when it hits a support/resistance level.

It may be interesting to note that despite all the literature about the benefits of trend trading, the majority of retail tradersÕ positions are still of the range/ counter-trend variety. How do I know this?

In recent years, retail brokers have released data about the holdings of their clients (retail traders) and the numbers almost always show that they buy as prices goes down, and sell as prices goes up.

 

from Oanda Corporation

In the graph above, the black line indicates the EUR/USD price over a 1 month period. The orange portion indicates the size of the net short positions, while the blue portion indicate the net long positions.

The graph gives us a snapshot of how the trade positions of traders changed over time. Notice that as the price (black line) moves down, retail traders tend to take (and hold onto) long positions.

And just in case you think this rarely happens, it doesnÕt. It happens almost all the time. See for yourself here:

http://fxtrade.oanda.c ade.oanda.com/analysis/h om/analysis/historical-positions istorical-positions http://fxtr

The takeaway takeaway is that in spite of all the talk and discussion about trend trading, most traders simply donÕt do it.

Why?  

 Perhap Perhaps, s, it is due to a lack of disciplineÉ but I believe the real reason to go deeper than that.

Allow me to explain by asking a question:

Do you need discipline to hold yourself back from touching a hot stove?

Hopefully Hopefull y, you answered ÔnoÕ. ÔnoÕ.

You know very well the consequences of touching a hot stove, so it is only natural for you to avoid it. ÒDisciplineÓ wouldnÕt be necessary.

In the same vein, I believe most retail traders are unable to stick to trend trading not because they are ill-disciplined, but because they donÕt have a clear, uncompromising understanding of why they should.

Thus, before we talk about anything else, we must first begin with the fundamental reasons behind trend trading.

What is trend trading exactly? And why should we stick to it?

WeÕll We Õll answer these questions (and more) in the next section.

 

 

Why Trend Trading?

So why should we focus on trend trading instead of range/counter-trend range/counter-trend trading?

The short answer, is that a trend trading strategy is most likely to be the optimal one for retail traders.

You see, it boils down to how the retail trading industry is structured.

To succeed in any game (of which retail trading can be considered to be one), weÕll first have to study the rules and their implications for the players involved.

Imagine a coin toss game where thereÕs an equal chance for the coin to land on either side. In this game, we can either double our stake if we bet on the winning side, or lose our stake if we bet on the losing side.

In a game like this, we should probably choose not to play at all, since the profit expectation in the long run would be zero. This is often referred to as a zero sum game, where every $1 lost by a player is won by another player.

However, this is not how retail trading is structured. Instead, itÕs a lot more like a card game at the casino, where the house takes a cut out of every game thatÕs played.

This results in a different dynamic compa compared red to the coin toss game, with the overall expectation here being negative Ñ that is to say, that every $1 lost by a player results in only a gain of $0.90 to another player (with $0.10 going to

the broker/de broker/dealer). aler).

 

  SoÉ as retail traders the first thing we have to be aware of is that the average profit expectation of the trading game is less than $0 (i.e. worse than betting on a coin toss).

And, weÕd also have to consider that the professional (institutional) traders traders in the market are faster, more well-informed and have a lot more capital to trade with, than we do.

This puts us at a significant disadvanta disadvantage ge and everything else being equal, weÕd probably get our asses kicked if we compete directly against them.

So even though our average profit expectation is less than $0 (statistically speaking), in practice it is probably a lot  lower  lower than $0.

At this point, you might be starting to feel a little discouraged about this whole trading business. If so, youÕre on the right track.

The reality is that retail traders tend to lose money because the industry is structured with the odds stacked against us. ItÕs really that simple.

And this is isn't even considering our tendency to self-sabota self-sabotage ge by entering and exiting trades at exactly the wrong times, due to psychological biases.

Probabilistically Probabilisti cally speaking, we are are primed to lose in the long run.

ThatÕs the sobering fact you need to know if you want to get serious about trading.

 

And, as you might have guessed, the only way to make money in such an environmentt is to employ an approach with the best chance of tilting our profit environmen expectation into positive territory.

How can we do this?

The answer lies not with trading from statistical (quantitative) approach, approach, but from a qualitative one.

Trade Quantity vs Trade Quality A quantitative trading approach approach benefits the party that has the odds in his favour.

For example, a casino has an approximate 3.5% advantage (positive expectation) over the players players at the blackjack tables. With this statistical advantage, advan tage, the main incentive of the casino is to get as many people to gamble as often as possible.

The casino owner doesnÕt care whether the house wins (or loses) at each round of blackjack, because he knows that the more people gamble, the more money heÕll make over time.

This is also how trading brokers (market makers) operate. By charging a spread fee, they essentially tilt the odds of making a profit in their favour, and are incentivised to get their customers (retail traders traders)) to trade as often as possible.

 

 

For retail traders however, a quantitative approach to trading is a losing game since we start out at a statistical disadvantage.

Thus, the only way for us to make money over the long run is to employ a qualitative trading approach.

Unlike a quantitative approach Ñ in which weÕd want to take as many trades as possible Ñ a qualitative approach involves being selective with our trades, and taking as few of them as possible. possible.  

By limiting our trades to only the top quality ones, we reduce our exposure to the default odds that are stacked against us.

To explain this point, imagine the market to be a big box of mostly rotten apples, but with each apple being sold at an equally cheap price.

As traders, we are like the customer who has to close our eyes and rely only on our sense of touch to pick out the apples we want. Not all apples in the box are rotten, and there are some very good deals to be enjoyed if we are able to pick out the good apples.

The more times we dip our hands into the box, however, the more likely we are to pick out a rotten apple (after all, there are many more rotten apples than good ones).

Naturally, the savvy apple merchant wants us to pick as many apples as possible, since doing so would increase i ncrease his chances of selling us the spoiled ones.

 

In the same way, our brokerÕs incentives are inconsistent with ours. They want us to trade as much as possible, while we should be staying out of the market as much as possible.

The takeaway here is that the more often we enter the market, the more likely we will lose in the long run.

To SummariseÉ

With a quantitative approach to trading, the reason for each trade doesnÕt matter. The only thing that matters is the number  of  of trades taken. The more trades, the better the chances of making money.

With a qualitative approach, the reason for each trade matters. When the average profit expectation is negative, the only way to make money is to take the few trades that are most likely to make money, and ignore all other (low quality) opportunities.

The key point is that we should trade with an approach that does not require us to take a large number of trades. And when we do take trade, we must be reasonably certain that thereÕs a good chance of it being a winner.

The next section will further elaborate on these points.

  Expected Value  

 

In statistical theory, thereÕs a concept called expected value.

It refers to the (theoretical) aver average age result of an event, based on the probability and magnitude of each possible outcome.

The formula for expected return is one of the cornerstones of our trend trading approach. LetÕs take a look at its components:

(PW x AW) + (PL x AL)

PW = Probability of winning AW = Winning amount PL = Probability of losing AL = Losing amount

To understand this formula, letÕs use the example of a coin toss. If we bet on  ÔheadsÕ and win, weÕll mak make e $100. But if we lose, weÕll part with $100.

Now, since thereÕs a 50% chance for the coin to land on either side, the expected value of this game would be:

(50% heads x $100) + (50% tails x -$100)

Éwhich can be expressed as:

 

(0.5 x $100) + (0.5 x -$100)

The answer to this equation is $0, which is the expected value of this game.

 

This means that in the long run, we should expect to make $0 (weÕd just break even).

Now imagine playing the same game, but this time with a rigged coin that lands ÔheadsÕ up 55% of the time.

Our expected value of this game would be:

(0.55 x $100) + (0.45 x -$100) = $10

Thus, in this rigged game we can expect to win an average of $10 over time.

Of course, we will never actually make $10 since our final result must be a multiple of $100 (we can only win or lose $100 each time).

However, the benefit of the expected value formula is that it helps us think objectively about the relationship between probabilities, payoffs and the expected result.

Let me explain further: which of the following bets should you take?

1. A 55% chance chance to wi win n $100, $100, and a 45% chance chance to to lose $100; $100; or or 2. A 40% chance chance to win $1 $140, 40, a and nd a 60% chanc chance e to llose ose $70? $70?

 

Intuitively, the answer might not be clear.

But if we apply the expected value formula, formula, we know that these bets yield an expected value of $10 and $14 respectivelyÉ so we should take the second bet!

Now what has this got to do with trading?  

 

Well, letÕs consider the fundamental assumption of trend trading: Prices are more likely to move in the direction of the trend than against it.

This means that everything else being equal, the chances of winning a trend trade is likely to be greater than 50%.

But since thereÕs no way to tell the exact probability of winning, letÕs be conservative and assume a 51% chance.

Using the expected value formula, we get:

(0.51 x AW) + (0.49 x AL)

Now what does equation this tell us?

It tells us that if the winning amount (AW) is at least equal  to  to the losing amount (AL), weÕll end up with a positive result.

For example, if each trend trade will either profit us $100 or lose us $100, this is what the equation will look like:

(0.51 x $100) + (0.49 x -$100) = $2 $2  

In this example, weÕd end up with a positive expected value of $2.

 

At this point, it would be appropriate for me to clarify that is only meant to be a philosophical concept. After all, there is no way to know the actual expected value of trend trading, since (unlike a coin toss game) the limits of price trends cannot be defined.

The expected value formula simply serves as a mental framework to help us think about how the probability  of  of winning relates to the winning amount  to  to yield the expected result.

  Now what if we trade with a better risk-reward ratio, where each trade would either profit us $150, or lose us $100? In other words, with a risk risk-reward -reward ratio of 1:1.5?

HereÕs HereÕ s the equation for this scenario:

(0.51 x $150) + (0.49 x -$100) = $27.50

Do you notice something here?

With just a 50% improvement in the risk-reward ratio, the expected value increases over 1,300% !

And all this with just a 2% higher chance of winning over losing. With practice, our winning percentage can certainly improve. improve.

Ultimately, our trading results will be determined by the winning

 percentage and the risk-reward ratio,  ratio, which is expressed by this formula.

 

 

This is the crux of why we will focus on trend trading. It gives us the best chance of winning trades (more than 50%), and with a better risk-reward ratio (i.e. better than 1:1).

This is how we can succeed as retail traders even though we start out at a statistical disadva disadvantage. ntage.

As we go through the coming chapters, keep this philosophy in mind and things will quickly make sense.

 

Basic Trend Framework A common indicator used to identify price trends is the moving average average line. This is not a beginners book so IÕll assume you are familiar with how it is calculated and how it works.

The thing about the moving average line is that itÕs a lagging indicator, which is why we wonÕt be using it to determine our trade entries or exits.

Instead, weÕll use it as a secondary tool to remind us of the overall strength and direction of an ongoing trend.

We can use any period setting that isnÕt too short (less than 30) or too long (more than 50). The reason for this is because we want a moving average line thatÕs relatively stable while at the same time not lagging too far behind the market price.

Personally, I like the 40 period simple moving average (40SMA). average (40SMA).

The 40SMA will remind us of the direction of the trend (based on whether itÕs moving up or down), and the strength of the trend (based on how steep the line is).

LetÕs go through an example to see how this is done.

 

 

In the chart above, prices are clearly in a downtrend.

However, there might be more to this trend than meets the eye.

LetÕs now add the 40SMA indicator to the chart and see what we find.

 

  Looking at the slope of the 40SMA, we can tell that the downtrend is slowing down Ñ it is losing momentum.

This information will be helpful if i f weÕre thinking about entering a new trade, or closing an existing one.

Later on, in combination with what weÕll learn about the wave and trend structures, the moving average average line will help us assess the overall ÒhealthÓ of an ongoing trend.

Moving on, letÕs examine the basic components of a price trend.  

 

Waves, Peaks & Valleys

When prices trend, they tend to move in a zigzag manner called ÒwavesÓ.

The best way to understand this is with an example. Below is a basic candlestick chart of an uptrend:

If you notice, these price movements can be separated into distinct ÒupÓ and  ÒdownÓ sections.

The next image shows the same price chart, but with an emphasis on the waves.  

 

By (mentally) simplifying a price chart into waves, we can better visualise the characteristics characte ristics of the trend weÕre looking at.

But before we get into that, letÕs first take a closer look at each individual wave.

In a price trend, there are two types of waves: impulse and pullback waves.

 

  Impulse waves are waves are waves that move in the direction of the trend. They are typically larger (i.e. longer) than pullback waves waves..

Pullback waves are waves are waves that move in the opposite direction of the trend. They are typically smaller than impulse waves, and are sometimes called correction waves.

An impulse wave will always be followed by a pullback wave, and vice versa.

 

  The points where an impulse and pullback wave meets is either called a  peak   or a valley .

A peak peak is  is the point where an up-moving wave meets a down-moving wave, while a valley valley is  is the point where a down-moving wave meets an up-moving wave.

 

  When prices are trending up, weÕll expect to see consecutive higher peaks and higher valleys.

A higher peak refers to a peak thatÕs higher than the previous peak, and a higher valley refers to a valley thatÕs higher than the previous valley.

 

  Similarly,, when prices are trending down, weÕll expect see consecutive lower Similarly peaks and lower valleys.

A lower peak refers to a peak thatÕs lower than the previous peak, and a lower valley refers to a valley thatÕs lower than the previous valley.

 

 

End Of The Trend

For our purposes,  purposes, a trend is considered to be over when:  when: 

¥ Prices move below the latest valley in an uptrend; or when downtrend.   ¥ Prices move above the latest peak in a downtrend. 

End of Uptrend

In an uptrend, we should only see consecutively higher valleys. So the moment

we see a lower valley, we consider the uptrend to be over.

 

End of Downtrend 

In a downtrend, we should only see consecutively lower peaks. so the moment we see a higher peak, the market is telling us that the trend is over.

When the trend ends, we will no longer be looking to trade in that market until it starts trending again.

 

 

Wave Strength

Impulse and pullback waves come in a variety of forms, but they can generally be classified as ÔstrongÕ or ÔweakÕ.

The strength of a wave is determined by the number of pips moved, moved, and the the time it took to took to do so.

The further and faster the wave moves, the stronger it is.

To illustrate, hereÕs a basic candlestick chart:

 

Now letÕs take a look at the strength of each impulse wave:

 

 Now letÕs examine the strength of each pullback wave:

In general, the stronger the impulse waves and the weaker the pullback waves,, the more likely the trend will continue. waves

In a later chapter, weÕll examine this topic in further detail.

For now, weÕll move on to examine the basic types of pullback waves.

 

Pullback Wave Types There are 3 basic types of pullback waves:

1. Type A pul pullba lback ck wa wave ve 2. Type B p pull ullbac back k wav wave e 3. Type C p pull ullbac back k wa wave ve

Each pullback wave type corresponds to the extent  of  of the pullback in relation to the impulse wave.

Type A Pullback

A Type A pullback is one that does not  move  move back to the halfway halfway point  point of the impulse wave. In trader-speak, we say that prices did not reach the 50% pullback level.

 

  Type A Pullback Example (uptrend)

 

Type A Pullback Example (downtrend)

Type A pullbacks are the weakest among the 3 types. They typically occur when the price trend is strong.

 

 

Type B Pullback

A Type B pullback is one that moves to approximately the halfway point of the impulse wave.

Type B Pullback Example (uptrend)

 

Type B Pullback Example (downtrend)

 

 

Type C Pullback

A Type C pullback is one that moves significantly beyond the halfway point of the impulse wave.

Type C Pullback Example (uptrend)

 

Type C Pullback Example (downtrend)

Type C pullbacks are the strongest among the 3 types. They typically occur when the price trend is weak.

The rule of thumb regarding pullback waves is: the stronger pullback waves, the weaker the trend.

By the way, these wave pullback types are only observable in hindsight. We can never know in advance how far an ongoing pullback will go until itÕs over. Thus, this concept is only applicable in assessing pullback waves waves that have

already happened. Nonetheless, Nonetheless, this is a useful way to judge the overall quality of an ongoing trend.  

 

Entry Philosophy

This chapter explains where we will enter our trades, and why. This is typically a favoured topic among traders, traders, as it is the most exciting one to talk about.

However, if we truly understand of the philosophies behind trend trading, the trade entry method would pretty much select itself Ñ we wouldnÕt be left with much of a choice.

LetÕs begin by considering the limits of our knowledge.

What canÕt  we  we know about trend trading?

We canÕt know for sure:

 the trend will continue ¥ If  the ¥ When the trend will continue  (and for how long) the trend will continue ¥ How far  (and

Well thenÉ what can we know for certain about trend trading?

The only thing we know for sure, is that we want to get out of the market the moment the trend is over.

In other words, as soon as the trend ends, there is no longer any reason to keep a trade open, and we should close it immediately.

 

Recall: The Recall:  The default trading odds are stacked against us. The longer we stay in the market, the more we are exposed those odds.

  Our trade entry will thus be based on the one thing we know for sure: where weÕll definitely close the trade when the trend ends.

In this sense, our trade entry will be paradoxically determined determined by our predetermined trade exit.

How would this work?

LetÕs revisit the expected value formula:

Result = (0.51 x AW) + (0.49 x AL)

Recall that in order for the expected value (expected result) of our trading to be positive, the winning amount (AW) must be at least the same size as the losing amount (AL). That is to say, weÕll need a minimum risk-reward ratio of 1:1.

Keep in mind that this formula presumes that price price  trends are more likely to continue than reverse.  reverse. 

 

  Uptrend

 

Downtrend

In summary, summary,

1. WeÕll def definitel initely y be closing closing the tra trade de when prices prices move move be below low the lat latest est valley in an uptrend (or above the latest peak in a downtrend) 2. We assu assume me that that prices prices are more more like likely ly to make make a higher higher peak peak in an uptrend (or a lower valley in a downtrend) 3. We should on only ly enter tr trades ades with with at least least a 1:1 risk-rew risk-reward ard ra ratio tio

Point 1 tells us where to set a stop loss, while Point 2 tells us where to set a profit target.  

 

Now that we have determined where to set the stop loss and profit target, there is only one place to set our trade entry order so that we have a 1:1 riskreward ratio: at the halfway point of the latest impulse wave.

 

  Uptrend   Uptrend

  Downtrend 

 

Does this make sense?

If it doesnÕt, re-read this section again until you understand the reasons for setting the stop loss, entry and profit target levels in this manner.

ItÕs important that you understand the thinking process behind these decisions.

 

Now of course, we can also set our trade entry with a better risk-reward ratio, like this:

But donÕt forget: the larger the pullback wave, the weaker the trend is.

There is thus a conflict here, because as much as possible, we want to take trades with a risk-reward risk-reward ratio better than 1:1É but if we get it, it also means that the trend is weaker than weÕd like it to be.

In a later chapter, weÕll look at how to deal with this conflict by extending our

profit target. For now though, weÕll settle for taking trades at the 50% pullback level of the latest impulse i mpulse wav wave. e.  

 

Trading Time Frame

In theory (i.e. in the absence of real-life constraints), we can trend trade on all available time frame charts.

In practice however, it will not make sense to do so on time frames lower than 4 hours.

Why? Because when we trade on the smaller time frames, the  proportion of profits that go to the broker (in spread fees) will be relatively large, which works against our chances of survival in the market.

In a nutshell, hereÕs what I mean:

Short Term Trade Medium Term Trade

   

ProÞt

Spread Fee

Fee Percentage

20 pips

2 pips

10%

100 pips

2 pips

2%

In taking short term trades, weÕd have to pay our brokers a significantly larger portion of our hard earned profits than if we traded on the longer timeframes. timeframes. Of course, the brokers know this. This is why they tend to promote short term trading. ItÕs good business for them.

Now consider that every extra dollar we pay the broker (in spread fees) is another dollar lost from our bottom line. li ne.

In an environment specially set up for retail traders to lose, every extra dollar

we save is another one that keeps us alive and thriving. With this in mind, we will focus on trading the 4 hour and hour and daily time frames. frames.   

Trend Appraisal In a previous chapter (Basic Trend Framework ), ), we examined the overall structure and basic components of a price trend.

Now in this chapter, weÕll zoom in on the less obvious details that will determine whether we should be participating in the trend weÕre looking at.

Not every trend is worth trading, and if we want to succeed over the long run we have to learn to identify the types of trends to avoid.

Think of Trend Appraisal as a filtering process upon which the poor quality trends are Ôweeded outÕ, outÕ, so we can focus our time and attention on the trends that are more likely to provide us with winning trades.

When it comes to judging the quality of a price trend, there are essentially 3 dimensions to it:

1. Wav ave e Regul egular arit ity y 2. Trend rend Pot oten enti tial al 3. Ec Econ onom omic ic Fund Fundam amen enta tals ls

 

 

1. Wave Regularity This dimension is about the consistency  of  of the length of the impulse waves.

In a high quality price trend, the length the impulse waves tend to be similar:

 

  In a poor quality trend, the length of each impulse wave tends to be significantly different than the others:

As much as possible, we want to only trade the markets that have consistent, regular impulse waves and avoid trading the markets with erratic impulse waves.

 

 

2. Trend Potential

Trend Potential, as the name suggests, is about estimating the likelihood for prices to keep trending in the near future.

As a rule of thumb, the longer a trend has been running in the absence of fundamental drivers drivers (i.e. fundamental reasons), the less likely it will continue.

For example, if there is no significant change in the economic fundamentals in the Eurozone or United States, we would not expect a significant price trend on the EUR/USD.

The implication of this is i s that weÕll need to have a basic understanding of economic fundamentals, and I recommend that all traders spend time studying it. In the next section, weÕll talk more about this topic.

The next thing to look out for is a technical over-exte over-extension nsion of the trend.

This happens when we see a divergence on the Relative Strength Index (period: 14) indicator.

*Note: It doesnÕt really matter which method (or indicator) you use to estimate the technical over-extension over-extension of a price trend, as long as you understand how it works and it does not contradict the trend trading philosophy.

 

 

In the chart above, we see that this market was initially in an uptrend, with a series of higher peaks and higher valleys.

Towards the middle of the chart however, we see that although prices continued to make higher  peaks,  peaks, the RSI line was instead making lower  peaks.  peaks. This is what we call an RSI divergence. divergence.

The idea here is that in an uptrend, the RSI line should form higher peaks as

the market price forms higher peaks.

 

 Similarly, in a downtrend the RSI line should form lower valleys as the price forms lower valleys.

In the chart above we see that prices were initially in a downtrend, and in the middle of the chart we see prices forming a lower valley (as it should).

However, notice that the RSI line formed a higher  valley  valley instead. This is a sign of a potential reversal, and we should not be looking to take a trade here.

RSI divergences do not guarantee a price reversal (nothing can), but they are reliable enough for us to add to our trading toolbox, especially when applied in combination with the other concepts covered in this book.  

The last way to gauge the potential of a price trend is with simple support/ resistance lines.

In accordance with basic technical analysis, we can draw horizontal support/ resistance lines on lines on the chart to mark out the major price level(s) where the market price had previously been unable to penetrate. penetrate.

If the market price begins to approach these support/resistance support/resistance areas, we will refrain from entering a new trade, or consider closing our in-the-money trades trades..

In the chart above we an initial strong impulse wave followed by a Type A pullback wave. And now recently, prices are in a weak uptrend.

 

  In this situation, there is clearly a major resistance level near the 1.6810 level. Thus, although prices are technically in an uptrend we will not be trading this market due to a significantly lower chance for the trend to continue.

Remember: The Remember:  The default expected value of retail trading is negative. This means that while a few retail traders may succeed succeed in this environment, most will not.

The looser we are about our trading criteria (i.e. more often we take trades), the more likely weÕll find ourselves in the latter group.

This is why we must act conservatively and take trades only  when  when odds are clearly in our favour.

 

3. Economic Fundamentals As trend traders, it will be very helpful for us to understand the basics of economic fundamentals, fundamentals, since they are often the main driver of large price trends.

The first thing to note is that medium-to-long currency prices are strongly influenced by expectations expectations  of  future interest rates. rates.

The higher the expected future interest rate of a country (relative to that of another country), the more its currency strengthens.

For example, if people are expecting interest rates to rise over the coming months in the United States, while the interest rates in the Eurozone are expected to remain unchanged (or lowered), we can expect the EUR/USD to keep trending down as the U.S. Dollar strengthens relative to the Euro.

In this sense, a basic understanding of interest rate policy (monetary policy) is crucial for us because it often determines the direction direction and  and magnitude magnitude of  of currency price trends. The more interest rates are expected to change, the further currency prices will trend.

This begs the questionÉ how do we know whether interest rates are expected to rise, fall, or remain unchanged?

The answer lies in economic indicators.

 

 

Quick Definition

Economic indicators are official studies and surveys that measure how an economy is doing. They measure national production statistics, sales numbers, consumer sentiment, employment employment levels and inflation, among other aspects of an economy.

The more positive these numbers, the faster an economy is expected to grow, and the more the Central Bank will be expected to raise interest rates to cool down the economy.

Economic indicators tell us how well an economy is doing, which helps us avoid taking trades in the wrong direction.

For example, if the economic indicators show a weak Eurozone economy, we can expect the European Central Bank to keep interest rates low. Thus, it might be a good idea to participate in a downtrend (if any) on the EUR/USD.

You can follow the schedule (and results) of economic news releases at the Forex Factory website (forexfactory.com).

I would also encourage you to record the historical data of important (highimpact) economic indicators so you can keep track of each nationÕs economic trends.

This is a topic we cover comprehensively in the Icarus Project. If youÕd like to find out more you can check it out at: www.pipmavensicarus.com  www.pipmavensicarus.com  

 

Wave Pairs A price trend can be viewed in terms of a series of impulse-pullback wave wave pairs:

By observing the dynamics of each wave pair, we can get a more accurate understanding of the overall price trend they are part of.

For each wave pair, we consider the pullback wave to be a reaction reaction to  to the impulse wave just before it.

Think of each impulse wave as the market saying, ÒI want to go this wayÓ, and

 

the pullback wave is the reply.

 

With this perspective, the size of the pullback wave (of each wave pair pair)) will tell us a lot about the likelihood of the continuation of the trend.

In particular, the larger the pullback wave and the longer it takes to form, the stronger its opposition to the impulse wave wave,, and the less likely prices will keep trending.

As discussed earlier, there are 3 types of pullback waves:

1. Type ype A pu pull llba back ck 2. Type ype B pu pull llba back ck 3. Type ype C pullb pullbac ack k

Among these pullback types, Type A is the one we will ignore for now, since Ñ as established earlier Ñ we should only enter a trade when prices make a pullback to the 50% level of the impulse wave (to maintain a 1:1 risk-reward ratio).

Thus, we will be trading only on wave pairs with either a Type B or Type C pullback.

Wave Speed In everyday life, speed is a measure of distance traveled over time.

Speed increases when:

¥ The same distance is traveled over a shorter period of time; or ¥ A longer distance is traveled over the same period of time  

Speed decreases when:

¥ The same distance is traveled over a longer period of time; or ¥ A shorter distance is traveled over the same period of time When we chart the constant  speed  speed of an object, we get a graph like this:

When we chart the increasing speed of an an object, we get:

 

 

When we chart the decreasing speed of an object, we get:

A helpful way to think about this is that the steeper the slope, the higher the speed.

As the line goes gets steeper over time, it means that speed is increasing, and conversely, if the line gets less steep over time it means that speed is decreasing.

In a similar manner, we can observe the ÒspeedÓ, or ÒstrengthÓ of the price waves.. The only difference here is that instead of measuring speed in terms of waves  Ôdistance traveled traveled over over timeÕ, timeÕ, weÕll measure measure it in terms of Ôpip movement movement over over timeÕ.

With this concept, we can assess the overall strength of a price trend by observing the speed of the individual waves.

 

WeÕll do this by:

1. Comp Comparing aring the the speed speed of each each impu impulse lse wave wave to the the spee speed d of the pu pullbac llback k wave (of each wave pair) 2. Obse Observing rving any any increase increase (or (or decrease) decrease) of speed speed among among the impulse impulse wave waves s 3. Obse Observing rving any any increase increase (or (or decrease) decrease) of speed speed among among the pullbac pullback k waves

Example:

Take a look at the chart above. What does the speed of the waves tell us about the overall trend?  

 

First wave pair (bottom pair (bottom left)

¥ Impulse wave started strong, but slowed down before the pullback wave ¥ Pullback wave was relatively weak (Type A) Second wave pair  pair 

¥ Impulse wave was not as strong as the previous impulse wave. There was a slight bounce (weakness) in the middle of this impulse wave

¥ Pullback was stronger (Type B) compared to the previous wave pair.

Third wave pair (top pair (top right)

¥ Impulse wave was strong  

 

¥ Pullback wave has not et formed

Based on these observations, we can tell that this trend started strong (with the first wave pair), but then started to weaken (with the second wave pair).

However, the latest (third) impulse wave has regained some of that strength so we can say that on the whole the trend is still looking ÒhealthyÓ and that we may consider trading it.

Another example:

What are the wave pairs telling us about this trend?

 

 

LetÕs seeÉ

First wave pair

¥ Impulse wave was very strong ¥ Pullback wave was weak (Type A) Second wave pair  pair 

¥ Impulse wave was significantly weaker (shorter) than the previous impulse

wave

¥ Pullback wave was strong(Type C), and was larger than the previous pullback wave  

This tells us that although the price trend started strong, it has now weakened considerably. In this case, unless there are strong fundamental reasons to join the trend, we would probably want to stay out of this market.

Big V Warning Sign There is a special type of wave pair that often signals the end of a trend.

It does not necessarily predict a trend change, but itÕs reliable enough to serve as a warning signal for us to stay out of the market.

I call it the Big V because thatÕs exactly what it looks like on the trading chart.

 

 

The Big V is formed when the market price makes a rapid move in the direction of the prevailing trend. This attracts the participation of other traders as they attempt to join in on the move.

Soon after though, the demand dries up and the price slingshots back in the opposite direction. Instead of making a slow, measured pullback, the market price quickly races back to its prior level, forming a symmetrical symmetrical V shape.

The defining characteristic of the Big V is the narrow narrow and  and steep steep V-shape  V-shape pattern.

 

Example:

 

 

Example:

The problem with the Big V is that most of the time it is identifiable only on hindsight. This is a problem for us because our usual trade entry is located at the 50% pullback level, which would be triggered before the Big V is fully formed.

So how can we avoid falling prey to a Big V reversal while looking to take our

trades?

 

The trick is to pay attention to how aggressive the pullback wave is. If we see the pullback wave moving quickly, weÕll simply stand aside and not  set  set a trade entry order.

We will only set a trade entry order (at the 50% level) after  we  we see the pullback wave moving in a slower, more measured pace.

For example:

In the chart above, we are not sure if a Big V will be formed here. However, looking at how aggressive the pullback wave is, that might just happenÉ so it would not  be  be a good idea to set a pending sell order at this point.  

 

Another example:

In the chart above, we see that the latest pullback wave did not rally aggressively following the impulse wave, and instead consolidated near the bottom. This is not what the Big V pattern looks like so it is now safe to set a pending sell order at the 50% pullback level as per normal.

The takeaway is that when we see an aggressive impulse wave followed by an equally aggressive pullback move, move, we should be on high alert and hold back

from setting a trade entry order.

We will only look to set an entry order when the pullback move looks weaker than the impulse wave.  

 

Wave Fractals A single wave on the larger time frame chart is often comprised of a series of smaller waves on a smaller time frame chart.

For example, each wave on the daily chart may consist of a series of smaller wave on the 4 hour chart:

This will be very helpful for us, since whenever we are doubtful or confused about any wave (or wave pair), we can simply zoom in and inspect the smaller time frame waves waves to get a more detailed look at the situation.  

 

Summary

This chapter is all about judging the quality of an ongoing price trend, to determine whether we should be trading in that market.

In particular, weÕd have to consider the characteristics of the wave pairs and the potential for the trend to continue.

This is important because one of the fastest paths to failure as trend traders is to blindly trade every trend we see. The market constantly tempts us with poor trading opportunities (bad apples) and it is our job to filter them out and to only spend our time on the good quality ones.

Ultimately, our trend appraisal skill will determine the level of our trading success. As such, I would suggest that you regularly come back to revise this chapter.

 

Trade Entry Procedure So far, weÕve examined trend trading concepts largely from a conceptual point of view. We discussed the what  and  and the why , and it is now appropriate to take a look at how  these  these concepts are applied in practice.

1. Firs First, t, weÕll open open up the the trading trading chart chart to th the e daily (or (or 4 hour) hour) time fr frame ame.. This is where weÕll look l ook for a price trend by observing the moving average average line and consecutively lower (or higher) peaks and valleys.

 

  2. Next Next,, weÕll pay pay attention attention to the v variou arious s characte characteristic ristics s of the trend ((that that we covered in the Trend Appraisal chapter) to decide if this is a trend we want to be trading.

¥ How long has the trend been going on? ¥ Are there any fundamental reasons supporting/driving it? ¥ How consistent are the price waves? Are the impulse waves slowing down? Are the pullback waves predominantly Type A, B or C? EtcÉ

¥ Does this trend have the potential to keep going? Are there any major support/resistance support/resistan ce levels coming up? Is there an RSI divergence?

3. Once w weÕve eÕve assess assessed ed the quality quality of the trend, trend, we will will decide decide to either trade trade it, or to look for opportunities elsewhere. If we decide to participate in the trend, we will wait for a pullback wave. 

¥ If the pullback looks aggressive (as in the case of a Big V), we will stay out of the market and monitor the situation. Once a Big V is i s confirmed, we will walk away not take the trade

4. If the pu pullbac llback k wav wave e isnÕt too aggre aggressiv ssive, e, a pending pending order order wil willl be set at the the halfway point of the latest impulse wave. A stop loss order will be set 1 pip behind the impulse wave, and the profit target will be set at the other end of the impulse wave (in the direction of the trend).

 

  5. If the tr trade ade is not not triggered triggered and and prices prices cont continue inue to trend, trend, we w will ill delete delete the pending order and wait for another pullback form the next impulse wave 

¥ If the pending order is triggered, weÕll move on to the trade management phase.

 

 

Trade Management Once a trade is triggered, weÕll watch for signs of trend weakness and be ready to manually close the trade, if the situation calls for it.

50% Pullback Reaction There are basically 3 scenarios that can happen after the market price hits the 50% pullback level (thus triggering our trade entry):

1. Price Prices s rejec rejectt that level level and quickly quickly move move back back in the direction direction of the the trend

   

2. Price Prices s ho hover ver near the 50% pullback pullback leve levell

3. Price Prices s mov move e past the 50% p pullba ullback ck level level and ke keeps eps moving moving clo closer ser to the stop loss level

Under the first two scenarios, we will observe the price action and be ready to move the stop loss order to the break-even price when prices move in our favoured direction with significant momentum.

In these two scenarios, the market is telling us that the pullback wave wave is relatively weak (compared (compared to the impulse wave), wave), so we can be patient and wait for the trend to resume.

 

 

Under the third scenario, things are a little trickier. What should we do when prices moves past our trade entry and approaches the stop loss order?

A simple approach would be to keep the trade open until prices either move back in the direction of the trend, or until the stop loss order is triggered. This is the option IÕd recommend for new traders.

Alternatively, we may choose to manually close the trade for a loss if we think the stop loss will probably be triggered. This approach requires a certain level of price acton competency and should only be reserved for more experienced traders.

 

 

  Money Management

 

Money management management is all about choosing the appropriate lot size to trade with. This matters because the size of our profits and losses are directly related to it.

You seeÉ see É When we trade with a large lot size, our profits and losses are large. When we trade with a small lot size, our profits and losses are small.

So although we would like our profits to be large and our losses to be small, the reality is that we canÕt have it both ways. W We e must either choose to be aggressive or defensive with our trading lot size.

And if we think about it, there is actually only one rational choice. Allow me to explainÉ

LetÕs say we take a series of 10 trades, t rades, each with a lot size that risks 4% of our trading capital. Now imagine that we win the first 5 trades, and lose the last 5 trades. Here are the results weÕd get:

Trade

Capital

% Risk

ProÞt

Loss

Result

1

$10,000

4%

$400

-

$10,400

2

$10,400

4%

$416

-

$10,816

3

$10,816

4%

$433

-

$11,249

4

$11,249

4%

$450

-

$11,699

5

$11,699

4%

$468

-

$12,167

6

$12,167

4%

-

-$487

$11,680

 

7

$11,680

4%

-

-$467

$11,213

8

$11,213

4%

-

-$449

$10,764

9

$10,764

4%

-

-$431

$10,334

10

$10,334

4%

-

-$413

$9,920

 

Notice that even though thereÕs an equal number of winning and losing trades, weÕd end up with less capital than we started with.

And in case youÕre wondering, the sequence  of the winning/losing trades doesnÕt matter. Here are the results if we had 5 losing trades followed by 5 winning trades:

Trade

Capital

% Risk

ProÞt

Loss

Result

1

$10,000

4%

-

-$400

$9,600

2

$9,600

4%

-

-$384

$9,216

3

$9,216

4%

-

-$369

$8,847

4

$8,847

4%

-

-$354

$8,493

5

$8,493

4%

-

-$340

$8,154

6

$8,154

4%

$326

-

$8,480

7

$8,480

4%

$339

-

$8,819

8

$8,819

4%

$353

-

$9,172

9

$9,172

4%

$367

-

$9,539

10

$ $9 9539

4%

$382

-

$9,920

 

And here are the results if we had alternate winning and losing trades:

 

Trade

Capital

% Risk

ProÞt

Loss

Result

1

$10,000

4%

$400

-

$10,400

2

$10,400

4%

-

-$416

$9,984

3

$9,984

4%

$399

-

$10,383

4

$ 10,383 $1

4%

-

$415

$9,968

5

$9,968

4%

$399

-

$10,367

6

$10,367

4%

-

-$415

$9,952

 

 

 

7

$9,952

4%

$398

-

$10,350

8

$10,350

4%

-

-$414

$9,936

9

$9,936

4%

$397

-

$10,334

10

$10,334

4%

-

-$413

$9,920

As you can see, the final result is the same Ñ we end up with less capital that we started with.

This is how the law of percentages works against traders. Even with an equal   number of winning and losing trades, weÕd still walk away with a net loss.

Now consider that as we lose more capital, it gets increasingly  harder  harder to make it back:

Starting Capital

Loss

Result

$ needed to break even

% needed to break even

$10,000

-1%

$9,900

$100

1.01%

$10,000

-5%

$9,500

$500

5.26%

$10,000

-10%

$9,000

$1,000

11.11%

$10,000

-25%

$7,500

$2,500

33.33%

$10,000

-50%

$5,000

$5,000

100.00%

$10,000

-75%

$2,500

$7,500

300.00%

$10,000

-90%

$1,000

$9,000

900.00%

If we lost 1% of our capital, we would have to make a 1.01% profit to get back to break even. If we lost 25% of our capital, it would take a 33.33% profit to do the same.

Now what if we lost 50% of our capital? We would then have to make a 100% profit just to break even.

These examples highlight another negative bias that traders face. As we lose

capital, it doesnÕt just get more difficult for us to break evenÉ it gets exponentially  more  more difficult.

 

In an earlier chapter we talked about the negative profit expectation suffere suffered d by retail traders. In this chapter, weÕre talked about the mathematical (percentage) bias of losses vs gains.

Both phenomena work against us, and the only rational way to deal with them is to trade less often, and with small lots.

Ironically, this is the opposite of what most retail traders do, which is to trade too often and with too large a lot size. Unsurprisingly, most of them end up losing money, after which theyÕd blame everyone else but their ignorance.

The simple truth is that they are not aware of the fact that the retail trading environmentt is structured  to environmen  to work against them in the first place. And not only that, the laws of mathematics punish losing traders more than it rewards winning ones.

The implication of this is that we have little choice but to trade conservatively conservatively rather than aggressively. For us, defence is more important than offence.

  Now we are ready to address the question: whatÕs the appropriate percentage of capital to risk per trade?

For our purposes, it would be reasonable to risk 1 - 2% of our capital per trade,, or less. trade

In practical terms, this means that if we have a $10,000 account, we may risk $100 - $200 per trade. If we have a $2,000 account, we may risk $20 - $40 per trade, and so on.

 

 

LetÕs say (for example) that weÕve decided to risk 2% per trade on a $10,000 account. ThatÕs $200 per trade.

WeÕve We Õve also just identified a suitable price trend and are just about to set a pending trade order:

In order to determine the lot size for this trade, weÕll need to know the stop loss allowance in terms of pips. In this case, the stop loss is 79 pips away pips away

from the intended entry price.

So for this trade, weÕll be risking $200 across 79 pips, which means that weÕll risk $2.53 ($200/79) for each pip of market price movement. movement.  

Now the question left to ask is: what trading lot size will enable us to risk $2.50 per pip? $2.50 

HereÕs a table that summarises the relationship between lot size and value-perpip:

Lot Type

Amount of Currency

Value per Pip

Standard

100,000

$10.00

Mini

10,000

$1.00

Micro

1,000

$0.10

Nano

100

$0.01

Since trading with 1 mini lot enables us to risk $1 per pip, weÕd have to trade with 2.5 mini lots (i.e. 25,000 units of currency) in order to risk $2.50 per pip. ThatÕs the appropriate lot size to use for this trade.

Note that since the stop loss allowance for each trade will be different (depending on the size of the impulse wave), wave), the trading lot size will be different as well.

By dividing the risk capital (in this case $200) across the stop loss allowance, we will risk only the intended amount (again, $200) regardless of the size of the stop loss allowance.

This ensures that in each of our trades, weÕll risk exactly the same percentage of capital even though the stop loss l oss allowances are different.

   

 

Trend Trading Philosophy Revisited Let us now go back to the bigger picture and revisit the reasons for trend trading.

So far, weÕve established that retail traders face a

1. Nega Negative tive profit profit ex expecta pectation tion (retail (retail trader traders s are net losers) losers);; and a 2. Nega Negative tive percen percentage tage bi bias as (% losses losses have have a bigger impact impact on ou ourr account account than % gains)

This means that if our winning percentage is 50% (or lower) and our riskreward ratio is 1:1 (or poorer), we are almost certain to lose in the long l ong run.

Thus, the only effective way to consistently make money in such an environment is to:

1. Hav Have e more more winning winning trades trades than llosing osing ones; ones; and/o and/orr 2. Prof Profit it more per per winning winning trade trade than is lost per per losing trade trade (i.e. (i.e. trade trade with a risk-reward ratio better than 1:1)

Trend trading is the most effective approach to satisfy both criteria, but we have so far only discussed the first one in detail.

Now, we are ready to fulfil the second criteria by extending our profit target.

 

Profit Extension Since our stop loss and entry orders will not be moved, the only way we can improve our risk-reward ratio is by extending our profit target.

However, in doing this we run the risk of prices reversing just after hitting our original profit target, without hitting the extended target.

Thus, we will cover our bases and close half the trade when the original profit target is hit, and allow the remaining half of the trade to continue running.

This way, if prices reverse after hitting the original profit target, weÕll at least have secured a portion of the profit. There are 3 ways we can extend the profit target:

1. At a pr predete edetermin rmined ed lev level el (ba (based sed on Wav Wave e Projection) Projection) 2. Wi With th tr trai aili ling ng sto stop p loss loss 3. Up Upon on a an n RSI RSI dive diverg rgen ence ce

1. Wave Projection Wave Projection is based on the hypothesis that the market moves symmetrically.

For our purposes, this simply means that the length of the latest uncompleted

impulse wave is likely to be similar to the length of the  previous impulse waves.

 

 

We can thus set an approximate profit target based on the length (in pips) of the previous impulse waves:

In this example, we see the the average average length of the previous impulse waves waves is 223 pips. To be slightly conservative, we may set the extended profit target 200 pips away from the latest valley.

 

2. Trailing Stop Loss Instead of setting a fixed profit target, we may simply set a trailing stop loss either beyond the previous dayÕs dayÕs high (or low) or beyond the latest peak (or valley).

This is a hands-off approac approach h and is the recommended recommended one for traders who donÕt wish to spend time monitoring their trades regularly. regularly.

The downside of this method is that traders will often give up a significant portion of their profits before the stop loss is hit and the trade is closed.

3. RSI Divergence An RSI divergence suggests an over-extension of the trend, and we may decide to close a profitable trade when we see a clear divergence between market prices and the RSI line.

Note that trends do not always end with a RSI divergence, so this is just something to watch out for, rather than to be expected.

In practice, I use a combination of all 3 approaches to decide where to close the remainder of my profitable trades.

 

  Trade Journal Back when I first started trading, I didnÕt keep a trade journal. I just wanted to make money and figured that a journal would just get in the way of that.

Looking back now, itÕs clear that I had it exactly the wrong way around around.. In fact, it was my insistence on not  using  using a journal that obstructed my progress.

For a long time, I was losing money in the market without understanding why. It was only later when I started keeping a trade journal that I realised I was repeating the same mistakes without being aware of it.

Now let me ask you: Do you think youÕre repeating the same trading mistakes?

Before you answer, bear in mind that most people would say no. When uncertain, people tend to give an answer that is i s most comfortable for them.

SoÉ do you think youÕre repeating the same trading mistakes? É .. .

Now hereÕs the kickerÉ kickerÉ

Regardless of your answerÉ answerÉ how do you know whether itÕs true?

 

Subjectivity Obstructs Progress  If you think you are repeating the same mistakes, how do you know that is in fact the case? LikewiseÉ if you donÕt think you are repeating mistakes, how do you know?

You see, we tend to answer questions like these anecdotally (i.e. based on memory).

Unfortunately, human memory is a highly unreliable source for objective information. People People tend to see what they want to see and believe what they want to believe.

by KC Green

Whether we like it or not, the most reliable way to remember our trading decisions is to write them down. This way way,, those decisions wonÕt be coloured by our mental and emotional biases when we try to remember them later.

This, in essence, is the function of a trading journal. It helps us to clearly

observe our trading performance without the cloud of emotional subjectivity.

 

 

If I may draw an analogy, keeping an updated journal is like driving a car with clear front and rear windshields. We can easily tell where weÕve been, and where weÕre headed.

Conversely, trading without a keeping journal is like driving a car with blocked windshields. We might think  we  we know where weÕre going, but the reality is likely to be very different from what we have in mind.

For us, updating and reviewing the trade journal are two of the most important things we can do to improve our trading trading..

What To Write Down The ultimate purpose of a trade journal is to provide an objective way for us to check on ourselves by answering the question: did I follow my trade plan?  plan? 

We will thus be recording, before we enter a trade order:

¥ A screenshot of the price chart on the 1 hour, 4 hour and daily time frames ¥ The entry, stop loss and profit target levels ¥ Any fundamental reasons for taking the trade After the trade is closed, we will:

¥ Take a screenshot of the price chart on the 1 hour, 4 hour and daily time frames

¥ Mark out on these charts where the trade was entered and closed ¥ Answer the question: did I follow my trade plan? ThatÕs it.  

With this, weÕd have a number of trades to review at the end of every month.

Upon reviewing each trade, weÕll ask ourselves:

¥ Why did I lose on this trade? What did I do wrong? Did I miss or forget anything? Is this an acceptable mistake? Was it preventable?; or

¥ Why did I win on this trade? What did I do right? If you can do this on a regular basis, youÕll be way ahead of most retail traders simply because youÕll be improving based on an objective measure while they continue to rely on subjective memory.

Once again, I cannot over-emphasise how important it is to keep a regularlyupdated trade journal. If I had to pick one thing that helped me improve my trading the most, this would undoubtedly be it.

Unfortunately, keeping a journal is often regarded as the most boring aspect of trading, which is why most people neglect it.

The good news is that once you start uncovering the mistakes youÕre repeating (via your journal), the process will quickly become enjoyable and perhaps even a little addictive.

 

  Complex Pullback Now that weÕve covered the core of the Practical Trend Trading strategy strategy,, we are ready to move on to an advanced topic: complex pullbacks.

In an earlier chapter, we defined a trend as prices making higher peaks and higher valleys (uptrend), or lower peaks and lower valleys (downtrend).

A complex pullback is an exception to this rule, and refers to a series of waves that give the appearance of the end of a trend.

HereÕs an example of how a complex pullback forms:

 

  In this chart we see prices moving in an uptrend with Ñ as it seems Ñ a new impulse move just underway.

At this point, a number of trend traders would be holding on to a long position with a stop loss order placed below one of the recent valleys.

However, look what happens nextÉ

The market price breaks to the downside, triggering the stop loss orders of the traders who were long this market.

 

 

According to our definition of a trend, we would now consider the uptrend to be over, since the prices have now formed a lower valley.

But look what happens next:

After shaking those traders off the trend, the market price quickly resumes the uptrend move!

This is what I mean when I say that a complex pullback gives the appearance  of the end of a trend.

 

In an uptrend, we expect to see consecutively higher peaks and valle valleys, ys, but a complex pullback (below, in red) red) breaks this rule.

The trouble with complex pullbacks is that they often move beyond the prior valleys in an uptrend (or beyond prior peaks in a downtrend), triggering tradersÕ stop loss orders that are placed there:

 

  Complex pullbacks pose a challenge for trend traders because there is no clear-cut way to deal with them.

There are however, a couple of precautions we can take to reduce or even negate the negative impact of complex pullbacks, when they occur.

1. Trade smaller lots in a trend with 2-3 (or more) impulse waves waves  

Complex pullbacks tend to occur after a trend has been running for some time. They rarely occur at the beginning of a trend.

Thus, when entering a trend with 2-3 (or more) impulse waves, we may choose to do so with a smaller-than-usual lot size, to reduce the loss in the event of a complex pullback.

2. Enter the trade at the 50% pullback level of past 2-3 impulse waves

Normally, we would set a pending entry order at the 50% pullback level of the latest impulse wave.

However, if we see that the latest few impulse waves are relatively small (i.e. short), we may instead set a pending entry order at the 50% level of the past 2-3 impulse waves, like this:

 

  This option should only be considered when there are strong fundamental reasons to believe that the trend will continue. Otherwise, we may very quickly find ourselves trading against the direction of a new (opposite) trend.

The ability to anticipate a complex pullback will ultimately be based on our assessment of the technical quality of the trend and the economic fundamentals of the countries involved.

 

 

Watch Out For Economic Indicator Releases

Price trends based on economic fundamentals rarely change in a single day.

More likely, it will take multiple economic indicator releases over a period of weeks (or months) before a major trend ends. This said, there are some highly sensitive economic indicators that can change short-to-medium short-to-m edium term trends when they are released.

A classic example is the Non-Farm Employment Report from the United States. This is the grand daddy of economic indicators, and a surprise number will often cause prices to fluctuate aggressively, aggressively, triggering out all but the luckiest tradersÕ stop loss orders!

To prevent such a situation from happening to us, we will not set entry orders on currency pairs that have high-impact economic indicators being released on the same day.  day. 

The release schedule can be found at the Forex Factory website: www.forexfactory.com/calendar. The ones we should avoid are the located next to the red icons (i.e. the high-impact releases).

I recommend that you check this site every day to remind yourself of the currencies to avoid trading for that day.

 

Wrapping Up Although weÕve spent a significant portion of this book going through the technical details of trend trading, the real value of this book lies in the philosophy behind it.

Allow me to summarise the major points from a different perspectiv perspective. e.

Every time we take a trade, we have to decide:

1. Wh Whet ethe herr tto o buy buy or sell sell 2. Wh Wher ere e to se sett th the e st stop op loss loss 3. Whe Where re to to se sett th the e pr profi ofitt ta targe rget(s t(s)) 4. Wh Wher ere e to e ent nter er tthe he ttra rade de 5. Th The e llot ot si size ze to us use e

Now, given that we start out with the following disadvantages:

¥ A default negative profit expectation (i.e. the more often we enter the market, the more likely weÕll lose in the long run) ¥ A negative mathematical/percentage bias (i.e. we can have the same number of winning and losing trades, and still lose money)

É whatÕs a type of trading approach that answers the above 5 questions, and avoids the 2 weaknesses?

The answer, is trend trading. Now letÕs go through the 5 questions in the context of trend trading.

 

  1. Whether to buy or sell

Although thereÕs no guaranteed way to predict future prices, we know that by definition, price trends are more likely to persist than otherwise.

It would thus be in our interest to enter trades in the direction of the prevailing trend.

2. Where to set the stop loss

Since we:

¥ Will only trade in a trend, and ¥ The trend is over when prices move beyond an impulse wave (in the opposite direction)

É then the logical thing to do is to set our stop loss just beyond the impulse wave.

3. Where to set the profit target(s)

Since:

¥ We expect a trend to continue, and ¥ A trend is maintained when prices make a higher peak (in an uptrend) or lower valley (in a downtrend)

É it would then make sense to set an initial profit target at the latest peak (in an uptrend) or latest valley (in a downtrend).

 

4. Where to enter the trad trade e

 

Through the expected value formula, we established that the most reliable approach to profits in the long run is to use trade with a risk-reward risk-reward ratio of at least 1:1.

Now, considering that the stop loss and initial profit target will be set at both ends of an impulse wave, this means that in order to maintain a 1:1 risk reward ratio, ratio, our trade entry point must be at the halfway point of the iimpulse mpulse wave.

5. The lot size size to use

 

Given that it gets increasingly i ncreasingly difficult to recover from growing losses, it is crucial that we never risk a significant portion of our trading capital on any one trade.

Thus, weÕll risk a small 1 - 2% of the trading account (or less) on each trade.