Secrets of Winning Forex Strategies

Secrets of Winning Forex Strategies How To Spot Trends And Patterns For Profitable Trades Nicholas Tan RANK BOOKS WWW.RANKBOOKS.COM

Published April 2013 Ebook Edition 2013 Published and distributed by: Rank Books Blk 1002 Toa Payoh Ind Pk #07-1423 Singapore 319074 Tel: 65-62508180 Fax: 65-62506191 Website: www.rankbooks.com Email: [email protected] ISBN 978-981-07-5971-1 Cover Design and Typeset: Rank Books This book was previously published as “Forex Trends and Profitable Patterns”. as a hardback edition. It is now republished as a paperback edition with a new title and updated with new information. All Rights Reserved. No part of this publication may be reproduced or copied in any form or by any means - graphic, electronic or mechanical, including photo-copying, recording, taping or information retrieval systems - without written permission of Rank Books. Conditions of Sale: This book is sold subject to the condition that it shall not, by way of trade or otherwise, be lent, resold, hired out or otherwise circulated without the publisher’s prior consent in any form of binding or cover other than that in which it is published and without a similar condition including this condition being imposed on the subsequent purchaser. While every reasonable care is taken to ensure the accuracy of information printed, no responsibility can be accepted for any loss or inconvenience caused by any error

or omission. The ideas, suggestions, general principles, examples and other infor- mation presented here are for reference and educational purposes only. This book is not in anyway intended to give investment advice or recommendations to trade. The author or publisher shall have no liability for any loss or expense whatsoever relating to investment decisions made by the reader. Acknowledgement: Special thanks to OANDA Corporation for granting the publisher the right to reproduce the charts which appeared in this book.

About the Author Nicholas Tan has more than 21 years of experience in the area of Forex trading, having worked for 13 years as a Forex trader with Bank Brussels Lambert and Chase Manhattan Bank. Armed with a degree from NUS in 1989, he worked his way up to vice president, making millions in those years. Since 2003, Nicholas has been trading for his own account and has coached numerous individuals on Forex. He is also the bestselling author of “Handbook On Forex Trading”: an easy guide to profitable currency trading, published by Rank Books. Nicholas Tan has been featured in the Channel News Asia program, “Cents & Sensibilities - EPISODE 6 - Money, Money, Money: Forex Trading” More details at: http://www.channelnewsasia.com/cents/episode6.htm About The Co-author: Goh Kheng Chuan is the author of the bestseller, Handbook For Stock Investors, a popular reading for new investors.



Dedication This book is dedicated to all my students, past and present, who have given me the confidence and inspiration to write this book

Message From The Author: Nicholas Tan When I wrote my first book, Handbook on Forex Trading in 2007, my aim was to provide an introduction and guide to forex trading. Forex trading was something relatively new at that time but was attracting a lot of interest from the retail sector. Once limited to the banks and high net worth individuals, the internet was fast providing a platform to retail players to join in the forex game. Without a sound knowledge of the forex market mechanism and strategies to trade with, retail players risk losing their capital in their haste to get on the forex bandwagon. Literature on forex trading was mainly from the west, and their foreign timing was causing a lot of confusion for local Singaporeans. As a result, my first book, and the first local forex book in local bookstores, was introduced. From many buyers’ feedback, many had problems applying the different patterns to the market situation. They were not sure which patterns to apply to the current market situation. In forex courses I have conducted, I encountered similar problems with students who were unable to identify the market condition and choose a right strategy and pattern to trade with the prevailing market condition. I get frequent emails regarding the appropriate strategies to apply. Knowing the strategies and patterns alone is not good enough; you need to know when to use them. Using good strategies in the wrong market conditions will still result in losses. One must be able to apply the right strategy to the right market condition to reap profits. As a result of this feedback, I decided to write another book. This time, I will use the market conditions encountered, and as a result of the market conditions, recommend strategies and patterns to trade accordingly with the prevailing market conditions. My new book will look at the market trend and stage of the trend. You don’t want to enter the trend at the ending stage! Knowing the stage of the trend will help you determine the appropriate strategy to apply to your trading in the prevailing market conditions.

With the experience of one book behind me and with much feedback from my readers and students, I hope you’ll find this new book an invaluable resource. I certainly have had great personal satisfaction in writing this new book. I hope all this will benefit you and help you on the road to becoming a successful trader in forex.

Message From The Co-author: Goh Kheng Chuan Forex trading is hard work and it requires knowledge, skills, and confidence. However, instead of starting from the basics, many new traders would go straight into the study of technical indicators that they can use to help them make money. They will diligently turn on assorted indicators on their computers, and after spending hours with their eyes glued to the screen filled with multi-coloured lines generated from the assorted indicators, few really know what they are looking at. This obsession with indicators reminds me of the popular fable of a group of blind men and an elephant. One blind man touched the elephant’s leg and said the elephant was like a tree trunk. The second man touched the elephant’s belly and said the elephant was like a wall, and lastly, the third man stroked the trunk of the elephant and said the elephant was like a tree branch. Soon, the three blind men started to argue with one another as to how the elephant really looked, as each of them knew he was right and accurate about his description. Indeed, all of them were right about the different parts of the elephant, but none of them were able to see the elephant as a whole to give the correct description of the elephant. The same problem applies to many new forex traders. They prefer to jump straight into the indicators and strategies without wanting to learn about overall market trends and price behaviours. They prefer to learn about the parts of the elephant rather than the elephant as a whole. Hence, in writing this book, we stressed the importance of understanding and reading trends and patterns before going deeper into the explanation and use of technical indicators. Part I of the book is focused on training the new trader to understand and appreciate market trends and patterns as a whole. Seasoned forex traders will know they cannot make money trading against the trend. Part II of the book will explain many effective technical indicators that traders can use to plan and

execute their trades with accuracy, coupled with real-life application of techniques and strategies. New forex traders will find this book very practical as it employs a step-by-step approach to teaching forex trading. This well-illustrated book is filled with real trading setups and will make you a more confident and profitable trader. Remember, in trading, the simplest tools are often powerful.



Contents PART I Understanding Trends and Patterns The Importance of Trends and Patterns What is a Trading Setup? The Uptrend End of Uptrend The Downtrend End of Downtrend The Sideways Movement PART II Forex Trends and Patterns in Action Part 2.0 Determining the Type of Trend Part 2.1 Stage of the Trend Part 2.2 Trading the Uptrend Part 2.3 End of the Uptrend Part 2.4 Trading the Downtrend Part 2.5 End of the Downtrend Part 2.6 Sideways/Range Pattern



PART I Understanding Trends and Patterns

The Importance of Trends and Patterns There are three ways a market will move. It can trend up, trend down, or move sideways. However, price does not move in a straight line within a major trend, but it can go zigzag before it goes up, or it can go down then up and make other moves in a combination of ups, downs, and sideways movements. These various movements give rise to a wide range of patterns. Luckily, within these patterns there are certain other patterns that are predictable and recurring, which makes trading profitable. Hence, by identifying and understanding what these recurring patterns are and what each pattern has the tendency to lead to, we will get a better idea how to predict the market’s next move. For instance, it does not take a rocket scientist to know that a heavy downpour is coming because we all know that before it rains there will be strong winds, some thunder perhaps, and the formation of black clouds in the sky. Hence, when we see any sign of these we immediately know that rain is coming. The same logic applies for understanding price patterns in predicting the movement in the forex market. Once you know how to spot these patterns, you will not be trading blindly nor will you be making wild guesses. However, even before you know how to spot them, you’ve got to know how they look, and this is the focus for Part I of this book. In Part I, we will show you the patterns within an uptrend, downtrend, and sideways movement, and how you can spot trading opportunities for each type of move. Each type of trend requires a different strategy to trade. In Part II of the book, we will go deeper to show you the tools you can use to plan your trade and the right strategy to adopt to tackle each type of pattern. Trading forex is like an army commander strategizing for a plan of action to deal with the enemy. You cannot come up with a good strategy and fight the enemy if you don’t know where they are located, the type of terrain they are in, the number of troops, their strengths and weaknesses, and finally, what their likely counter action will be should

you launch an attack. Only when you know what they are likely to do will you come up with better strategies to take them down. Part II of the book will provide you with the surveillance and confirmation tools (technical indicators) to help you select the right strategy to trade so that you can increase your profits and reduce your loss. Try to apply this analogy to spotting and trading patterns in the forex market. By knowing the next likely move, you will be able to form your trading setup or strategy.

What is a Trading Setup? When you have a trade setup, it means that you are on the lookout for a certain trend, pattern, or formation. Some traders may call it a trading plan or a trading strategy, but the concept remains the same. Once you spot a trend, pattern, or formation, you can visualise how the direction of the price will move and the outcome of the trade. Depending on the predicted outcome of the trade, you can decide to long or short the currency pair. In other words, once you have a trade setup, you have a visual image of your intended trading opportunity, and you will be able to visualise how the trade will develop as it starts to develop. If it turns out the way you expected for the setup, you make money. If it doesn’t turn out the way you expected then it is just a trade that didn’t work and you’ll have to take your loss. When you trade with a trade setup in mind, trading becomes less emotional since you already know what to expect. With less emotion involved in the trade, the more confident and disciplined you become, and these are the key factors that make a successful trader. Let me illustrate with a simple example of a trade setup for trading the double top formation. It is known to all traders that when a double top forms during an uptrend, it is a sign that the price will fall, and it is most likely that the uptrend is at its end and the price will fall further. Let me draw out the pattern and the expected outcome here to give you the visual image that you need to form in your mind.

Chart A: A double top formation With this pattern in mind, and assuming this is the only trade setup you know and the only currency pair you can trade is the EUR/USD, what should you do? You will look at the EUR/USD chart and look for an uptrend, and assuming you see an uptrend today and you spotted the double top formation, what do you do next?

Chart B: Expected outcome after a double top formation You need to know what is your trigger or entry point. Let’s say you tell yourself: “My entry point to short will be when the price falls and cuts the support level of the second peak.” I will place my stop loss 20 pips above my entry point and set my profit target at 30 pips (See Chart C). Then as you expected, price falls and now it cuts below the support level of the second peak, you will immediately short the currency pair and key in your 20 pips stop loss and your 30 pips profit target. A few minutes later, as expected, it fell 30 pips and reached your profit target. You are out of the trade and have made a profit.

Chart C: Trade setup turned out as planned The final outcome of your trade setup had gone exactly as planned and you had a winning trade. This is what a trading setup or a trading plan is all about. In this book, you will be learning many recurring patterns and setups that you can use for your own trading so you will not be trading blindly, not knowing what is the expected outcome of your trade.

There are different setups for different types of market trends. Some setups are simpler while some are more detailed and involve more than one technical indicator before you enter a trade. KEY QUESTIONS FOR DEVISING A TRADE SETUP • What conditions must be present for the trade? • What is the expected outcome of the trade setup? • What is the trigger that determines the point of entry? • Where should the stop loss be placed? • Where is the profit target objective? A Word Of Caution There are many people out there who are always on the constant lookout for a better forex guru who can offer them a better strategy that works 100% of the time. These people will learn one strategy, and when it doesn’t work out they will go on to learn the next strategy that others claim is working perfectly for them, and they’ll keep changing their strategies hoping that one day they will find the ultimate strategy that works 100% of the time. These people are not traders but dreamers chasing after something that doesn’t exist. Do not be taken in by anyone who claims they have a forex trading strategy that will guarantee you profits. It does not exist. The rule of trading is that if a proven strategy works more than 50% of the time, you should stick with it. Don’t throw it away when it doesn’t work for you once or twice. Accept the fact that there will be times when the setups do not go as planned. If every trade is to work out profitably all the time,

then why are there risks involved in forex trading? Why do people talk about risk management? A successful forex trader is not someone who makes money all the time but a trader who ensures that he makes more money than what he loses. Always aim to be more right than wrong, and in this way, you can be a profitable trader. We will apply this mode of thinking for each type of trend that we will discuss in this book. Always ask yourself when you are trading: What is happening now? What is likely to happen next? “Luck Is When Preparation Meets Opportunity”

The Uptrend An uptrend is formed when the price makes a series of higher highs and higher lows (see Chart 1.1). Chart 1.1: An uptrend with pullbacks - EUR/USD (28 Dec 2007) Trading Opportunities in an Uptrend a) RIDE THE TREND WITH PULLBACKS AND PAUSE The price does not move in a straight line when it trends up. Every uptrend will have its moments of pausing and dips or pullbacks, which present trading opportunities. By trading on pullbacks you can ride on the trend instead of sit- ting at the sideline and wondering when the trend will come to an end.

Let us take a closer look at a pullback in Chart 1.2A and Chart 1.2B. Notice that after two black candles, it resumed the climb, and this time, it climbed even higher with four white candles before it paused again. Chart 1.2A: A pullback

Chart 1.2B: After a pullback

Chart 1.3A: The bull flag pattern Flags During an uptrend, long bullish candles may form, rising 10 to 15 pips or more each time, and such sharp movements are common for certain currency pairs such as the EUR/JPY pair. After a sharp rise, it will take a rest and consolidate to form a bullish flag pattern. The sharp movement is referred to as the flag pole and the rectangle consolidation period forms the flag. Trading the Bullish Flag You will enter to buy once the upper trend line for the flag is broken. See Chart 1.3A

Chart 1.3B: A bullish flag formation - EUR/JPY Bullish Pennant During an uptrend, the price may move sideways and take a longer pause. The triangular consolidation will lead to the formation of a bullish pennant pattern, which generally appears as a triangular shape.

Chart 1.4A: The bullish pennant pattern

Chart 1.4B: A bullish pennant formation -GBP/USD Trading the Bullish Pennant You will enter to buy when the price breaks above the upper trend line of the pen- nant.



End of Uptrend All good things must come to an end, and so does an uptrend. There are many trading opportunities for trading at the end of an uptrend. If you have witnessed an uptrend and you have not entered a trade, you should wait patiently to trade the reversal patterns. Chart 1.5A: Trend line breakout Trend Line Breakout An uptrend is broken after the series of higher highs and higher lows is broken.

This is usually indicated by a downside penetration of the trend line and The forma- tion of a lower high. Chart 1.5A: A trend line breakout - USD/JPY Other signs of the end of an uptrend include looking out for the following bearish candlesticks reversal patterns, which indicate that the uptrend is losing strength and is set to reverse.

Bearish Candlesticks Reversal Patterns Hanging Man The hanging man indicates an uptrend reversal. It has a small real body (white or black) with little or no upper shadow and a long lower shadow. It does not matter if the body is black or white. Chart 1.6: Hanging man - GBP/USD

Bearish Engulfing Pattern The bearish engulfing pattern is a candle with a large real body that wraps a previous smaller white candle. It indicates that there is more selling than buying. Chart 1.7: Bearish engulfing - USD/CHF

Shooting Star The shooting star has a long upper shadow, and a small real body at the lower end of the price range. It has little or no lower shadow. The shooting star indicates an unsustainable short rally, after the price dips down to close nearer the opening price. Chart 1.8: Shooting star

Evening Star The evening star is formed by three candles. The first candle is a white body candle. The second candle is a small bodied candle, which closes above the first white candle, The third candle is a large black candle that covers at least 50 percent of the first candle. Evening Doji Star This is a variation of the evening star. When the second candle becomes a doji, it is called an evening doji star, which is more bearish than an ordinary evening star.

Bearish Harami Cross A bearish harami cross is a major reversal pattern. In an uptrend, a long white real body is followed by a doji, and that doji is contained within the previous large white body. Chart 1.9 Evening doji star

Tweezer Top The tweezer top is formed by two candlesticks with tops of equal length. The top can be composed of real bodies, wick and/or dojis. A tweezer top appearing in an uptrend is a reversal signal telling you that bulls are losing control and the uptrend is set to reverse and go down. TWEEZER TOP VARIATIONS In real market conditions, the two candles may not always appear to be side by side but separated by two or more candles.

Possible Tweezer Top Variations Chart 1.10: Tweezer top - EUR/USD

Three Black Crows Three black crows are a significant reversal pattern for an uptrend. They are formed by three consecutive black candlesticks that close near or at their lows of the period. Chart 1.11: Three black crows

Spinning Tops Candlesticks that have small bodies with upper and lower shadows that exceed the length of the body. The colour of the candles does not matter. Spinning tops signal uncertainty, and hence, spinning tops during an uptrend can be a reversal signal. Chart 1.12: Spinning top

Trading Opportunities for the End of an Uptrend An uptrend can end in many ways before it heads down. In this section, we will show you the possible patterns that may happen for an uptrend reversal and the trading strategy that goes with it. 1) THE 1-2-3 PATTERN OR THE A-B-C PATTERN Chart 1.13A: The 1-2-3 or A-B-C Pattern An uptrend does not end swiftly in the form of a vertical fall but it will fall and then consolidate for a period of time before it continues to fall downward again. This forms a three wave formation which is termed a 1-2-3 pattern, sometimes called the A-B-C pattern.

The point where it falls is called Point 1 or A, and the point where it stops is Point 2 or B. As the selling pressure eases, it will attempt to retrace its way up or go side- ways before it falls again (see Chart 1.13A). The point where it retraces or pauses is called Point 3 or Point C. After Point 3 or C, the downtrend continues. Without knowing the 1-2-3 pattern, new traders may mistake the retracement from Point B to C as a sign that the downtrend has ended and go long. But in reality, more downside is to be seen. In part II of the book, you will learn how to trade this pattern with the Fibonacci Retracement tool and how to identify entry and exit levels. Chart 1.14A: End of uptrend, 1-2-3 pattern - EUR/JPY

Chart 1.14B: End of uptrend, 123 pattern - EUR/JPY An uptrend may not end swiftly like the pattern shown above. Sometimes, the uptrend can be stubborn and just refuse to give up after it falls, trying to stage new highs before retracing again. The formation of a series of highs and lows formed in the process leads to the formation of three common patterns – the head and shoulder, double top and triple top formations before further downside is seen.

2) HEAD AND SHOULDERS PATTERN This pattern consists of three successive peaks. The second peak is the highest, forming the head, and the first and the third peaks form the shoulders. Draw a line connecting the two troughs to form the support line. Wait for the head and shoulders pattern to complete and sell once the neckline is broken. Chart 1.15A: Head and shoulders pattern

Chart 1.15B: Head and shoulder - USD/JPY (07 Jan 07)

3) DOUBLE TOP OR LETTER “M” PATTERN This is a pattern formed by two peaks of the same price level or close to the same level. It takes the shape of the letter “M”. This is formed when the price unsuccess- fully tries to make new highs but faces resistances and retraces again. Chart 1.16A: The double top pattern

Chart 1.16B: “M” formation - GBP/USD (02 Jan 08)

4) TRIPLE TOP The triple top is a pattern very similar to the double top. Instead of two, there are three peaks in the pattern. The peaks need not be exactly equal, but should be reasonably close to the same level. The trigger point is to sell when the support level of the lowest support level of the three peaks has been broken. Chart 1.17A: The triple top