Secrets of Winning Forex Strategies

as the triple top was forming. With each accompanying top, MACD was weaker and lower, indicating a loss of momentum. The MACD indicator does not give a sell signal; it warns us of a loss in momentum and a possible reversal in trend. This will help to confirm our view that the end of the uptrend is near. We can look to sell when the price breaks below the support line. Our stop loss can be placed at the high of the triple top. The profit objective is derived from the high to the support line. That height is taken and subtracted from the support line to obtain the profit objective. In chart 23.10, the high to the support line is 23 pips (1.0923-1.0900). The price objective target will be 1.0877 (1.0900-0.0023). With the end of the uptrend reversal, there should be a big move in store. As such, merely taking 23 pips out of the reversal with the above simple price objective may be too little. Another suggestion would be to use 1.6 times the profit objective. 1.6 × 23 = 36.8 pips. We will round it up to 37 pips. By subtracting these 37 pips from the support line, you will obtain the new profit objective of 1.0863 (1.0900-0.0037). HEAD AND SHOULDER PATTERN This pattern consists of three peaks with the highest peak in the middle. The other two peaks form the right and left shoulder. The neckline is drawn across the highest peak’s lows. When we encounter this chart pattern, the break of the neckline will confirm the head and shoulder chart pattern. We can use the RSI indicator to confirm this chart pattern as well. During the head and shoulder pattern, the RSI reading should peak with the head and lose momentum with the left shoulder. Sometimes, the RSI may peak on the shoulder before the head, and this is an additional warning of a top forming. Before the price

breaks below the neckline, most of the time the RSI will have a reading below 50, confirming the change in trend direction. Chart 23.10: Triple top pattern Trading the Head and Shoulder Pattern In chart 23.11, we should sell when the price breaks the neckline at 1.4561. Our stop loss will be placed at the peak of the head formation. The profit target is calculated from the height of the head to the neckline. In this example, that will be 23 pips (1.4578-1.4555). This should be deducted from the neckline at the breakout point, to obtain the price target of this pattern at 1.4538 (1.4561-0.0023).

Chart 23.11: Head and shoulder pattern 1-2-3 PATTERN In the end of an uptrend, sometimes you get a sharp fall followed by a rally that climbs almost as fast as it had gone down. It leaves you wondering if the uptrend has ended. Sounds familiar to you? One way to determine if the rally to point C is just a correction or if the correction has ended at B is to use the Fibonacci Retracement as a guide. If point C is just a correction it should not go beyond 85% of the movement from point A to point B. Most of the time, it should end the rally around the 62% Retracement level. So what is this Fibonacci Retracement tool?

Chart 23.12: The A-B-C/1-2-3 pattern WHAT IS THE FIBONACCI RETRACEMENT? The Fibonacci numbers are a mathematical series of numbers discovered by Leonardo Fibonacci da Pisa around 1170. This number series, 1, 1, 2, 3, 5, 8, 13, 34, 55, 89 >> on to infinity, is unique in a number of ways. If you add one of the numbers in the series to the number before it, you get the next number in the series, e.g. 5+8 =13. If you were to measure the ratio of any number to its next higher number, you get a ratio that is approximately 0.618. The higher the number you use, the closer it gets to 0.618. For example, 55 divided by 89 is 0.617977.

If you were to measure the ratio between any number and its alternate higher number you get 0.382. For example, 34 divided by 89 is 0.3820. With these, two ratios were derived to form part of the Fibonacci Retracement ratio. Another ratio, 0.5, is added to form the Fibonacci Retracement ratio. In most charting software, there is another ratio, 0.23 included together with the above 3 ratios. If you were to divide any number by its next lower number, you will get a ratio close to 1.618 (e.g. 89 divided by 55 is 1.61818). Does this 1.61818 sound familiar to you? Yes, we used it when we wanted a bigger price target to the original price target offered by a chart pattern. Now, back to our trading with the Fibonacci ratio…. Trading With the Fibonacci Retracement Ratio When we come across the ABC or 123 patterns, we can use the Fibonacci Retrace- ment ratio to guide us on the next likely movement in price. Drawing the Fibonacci Retracement ratio from point A to point B, we will expect the price not to retrace beyond 62% of point A to B. If the price does not move beyond 62%, we know that the rally to point C is a correction and the price will be expected to move below point B. However, if the price were to move beyond 85%, it would mean the rally to C is not a correction but a move likely to exceed point A. What if the price stays between 62% and 85%? In that case, our first assumption could be wrong. We will wait for the price to move beyond 85% to confirm the new direction However, if the price were to fall back below the 62%, then it is still a correction with a Retracement that exceeds 62%.

If the price peaks at point C and starts to fall, we can predict and project its next movement to point D. Point D is calculated from 1.6x the distance of point A and B. In the next example, we will show you how to trade with the Fibonacci Retracement ratio using the same chart as the below two charts. Chart 23.13: The point C rally Trading Example With the Fibonacci Retracement Ratio Once we have two points, A and B, we can draw the Retracement ratio. We will wait for point C to reach around 50% to sell. When the price reaches 1.4550, we can look to sell.

To protect our capital, we can place a stop loss at 1.4578, which is point A. The price should not go beyond 1.4578 if C is just a corrective rally. Our price target for our short position will be at 1.4510. This is 1.6 times the distance from point A to point B. Chart 23.14: Trading ABC pattern with Fibonacci

PART 2.4 Trading the Downtrend GRADUAL DOWNTREND WITH LONGER REST Chart 24.1: Gradual downtrend with longer rest From the chart 24.1 , we get an example of a gradual downtrend with longer rest periods in-between the downtrend movement. In this type of scenario, while the downtrend tends to be gradual, there is more sideways movement in-between the downtrend. The trend tends to rest for a while before it resumes its downtrend again.

As can be seen from the chart 24.2, between 2200 and 2300 hours, there was a drop with a pullback before midnight. After midnight, there was a period where the pullback took almost an hour before another push down to 1.9710. When encountered with this type of scenario, we could trade using a moving average to ride the trend during the pull-ups that occur during the downtrend. All trends do not go straight down; there will be pull-ups or pullbacks along the way. We can use the moving average as a resistance level. We will sell when the price is near the resistance level and cover back when the price drops to the previous low again. Chart 24.2: Gradual downtrend with longer rest with a moving average

CHOOSING A TECHNICAL INDICATOR TO USE In the chart above, a 30-period moving average is added. After adding a moving average to the chart, how do we trade with the moving average in this gradual downtrend with longer rests in the trend and sharper correction during the downtrend? We will trade with the trend. As the trend is down, we will look for an opportunity to sell when the price moves back to the moving average. The moving average is our resistance point. The price movement back to the moving average is the opportunity for us to sell and get into the trend. When the price goes back to the previous low we will cover back our position. As for our stop loss, it will be the previous high. With reference to the chart 24.3, let’s do an example.

Chart 24.3: A trading example with a moving average Trading Example of the Downtrend Using Pull-up Given the example, when the price goes back to the moving average at 1.9763, (see Chart 24.3) we will try to sell the pound as close as possible to 1.9763. Once we sell, we will be looking to cover back our short position at the previous low, which is at 1.9719. Along the way, the price goes back towards the moving average again at 1.9750. At this point, we can sell again as close as possible to the moving average. That would give us two short positions in this currency pair. Our target remains the same at 1.9719, but now it will be for our two positions in this currency pair. Less than two hours later, the Sterling pound reaches our target at 1.9719, and we cover our position as close as possible to this point.

Barely half an hour later, we have another situation whereby the price reaches the moving average again. We could repeat what we did earlier – sell as close as pos- sible to the moving average at 1.9735 and look to buy back at the previous low of 1.9713. DOWNTREND WITH A SHARP DROP Chart 24.4: Downtrend with a sharp drop One of the simple ways to get into a trend is by using a trend line. In the chart 24.4, the support line is being used as the trigger. During the downtrend, the price pauses for a moment. In fact, the price pauses for almost two hours after four hours of downtrend movement. During the two hours of pause and pull-ups, support was

created at 1.9508. We can define this support line and draw this support line as the trigger point. If the price breaks below this support line, we will sell. In the chart 24.5, we will show you an example of this simple but effective strategy. Trading Downtrend With a Sharp Drop From the chart 24.5, we can sell the currency pair once the price breaks the support line at 1.9510. Once we enter into a short position, we will place our stop loss at the previous high of the pull-up, which is at 1.9560. That is a 50 pips stop loss. Our profit objective would be 110 pips, which was the previous downtrend move. The downtrend started at 1.9620 and dropped to 1.9510 before the pull-up. Similar to the flag and pennant target objective, we will deduct 110 pips from 1.9560, which is the high of the pullback. That will give us a take profit target of 1.9450. Less than two hours later, that profit target was reached. That’s slightly more than 50 pips in the pocket in less than two hours.

Chart 24.5: Trading example of a downtrend with a sharp drop To some, the loss may be a bit too much to take; an alternative would be to place the stop loss at the high of the previous candle, which is at 1.9538 (see chart 24.6).

Chart 24.6: An alternative cheaper stop loss

TRADING WITH THE BEARISH FLAG When we encounter a bearish flag, we would wait for the price to break out of the lower uptrend line. Once the price breaks out of that line, we will enter into a short position. On chart 24.7 it indicates the sell location in trading a bearish flag. In the chart 24.7, we will try to sell as close to the break as possible. The stop loss can be placed at the highest point of the flag formation at 1.9522. The profit objective is calculated from the length of the flagpole and deducted from the highest point of the flag, which is our stop loss point as well. That would give us a profit target of 1.9470. Chart 24.7: A trading example of a bearish flag

TRADING THE BEARISH PENNANT How You Can Trade the Bearish Pennant Once we have spotted the bearish pennant, we will wait for the confirmation, which is when the price moves below the lower uptrend line. Once the breakout occurs, we will try to short the currency pair as close to the breakout point as possible. The stop loss is at the highest point of the bearish pennant, which is at 106.63. The profit objective is the length of the pennant pole deducted from the highest point of the pennant formation. That is where our stop loss is and will target a price move lower to 106.50. Chart 24.8: Trading example of a bearish pennant

PART 2.5 End of the Downtrend SIMPLE BREAK OF THE TREND LINE Similar to the end of an uptrend in Chapter 2.3, a simple trend line can help to determine the end of a downtrend and a reversal in progress. Trading With a Simple Trend Line In the chart 25.1, once the price breaks above the downtrend line that we have drawn, we will look to buy at 155.65. Our stop loss will be placed at the previous low before the break of the downtrend line. That is at 155.55. Our profit objective will be at the previous strong resistance. In the example below, the previous strong resistance is at 156.13.

Chart 25.1: A simple trend line signals the end of a downtrend END OF DOWNTREND CANDLESTICK REVERSAL PATTERNS In part one of the book, we mentioned about reversal candlestick patterns that tend to occur at the end of the downtrend. In part two of this book, you will learn how to trade those various patterns as you learned in part one. You will learn entry points and stop losses for the various patterns. And if you are right, where do you get out of those patterns? This section will concentrate on those reversal patterns that you are likely to encounter at the end of a downtrend.

1. Hammer The single candlestick hammer pattern is similar to the hanging man. The difference between the two patterns is in its location. While a hanging man occurs after an uptrend, a hammer appears after a downtrend. A hammer is a downtrend reversal pattern. Trading the Hammer Pattern With reference to chart 25.2, once we see the hammer pattern, we will look to buy the next candlestick as close to the opening of that candlestick as possible at 106.07. The stop loss will be placed at the low of the hammer candlestick itself, at 105.90. The profit target will be at the previous resistance level. In the chart 25.2, there are two possible strong resistance points. You could take half your profit by covering half your position at the first resistance point 106.52, with the balance at the second resistance point at 106.71.

Chart 25.2: A hammer candlestick pattern CANDLESTICK WITH TECHNICAL INDICATORS In Chapter 2.3, End of the Uptrend, we mentioned about candlestick patterns, where you can use a technical indicator to confirm the candlestick pattern. In that chapter, we gave an example of a spinning top. A RSI indicator was used to confirm the reversal signal given by the spinning top. In this section, we will give more examples of candlestick patterns and the use of an indicator to confirm the candlestick pattern. There are two common technical indicators, which you can use and they are the RSI and the MACD.

When using either of these two indicators, we are looking for an oversold market condition to confirm the bottom at hand. We can also use the divergence warning given by both the above two technical indicators. Indicator information is used to confirm the candlestick patterns. By itself, an oversold condition or divergence is not a signal to sell but rather a warning of a reversal. 2. Bullish Harami Cross In this pattern, there are two candlesticks that form the pattern. The first candle has a long black body. The second candlestick, in the form of a doji, is contained with in the body of the first candle. Trading the Bullish Harami Cross When we see the doji formed, which confirmed the bullish harami cross pattern, we will look to buy at the opening of the next candle. Before we rush into the market to buy, we can check the MACD indicator for confirmation.

Chart 25.3: The bullish harami cross pattern In this case, we see that the MACD has given a bullish crossover just when the candlestick pattern occurs. With both the technical indicator and the candlestick pattern telling us to buy, not only will our confidence be higher, but our success level will also be much higher. In the chart 25.3 we will buy at around 1.9494, and our stop loss will be placed at 1.9489, which is the low of the current downtrend. Our profit target is at 1.9516, which was the previous resistance before the downtrend.

3. Morning Star This triple candlestick pattern is the opposite of the evening star. The first candle is a black body. The second is a small body and its colour does not matter to the pattern. The third is a white body, which must cover at least 50% of the first black body. Trading the Morning Star When we encounter this pattern, we will look to buy the opening price of the next candlestick following this pattern. In the chart 25.4, the MACD is not giving very good information and is unable to confirm this pattern. We will buy at 1.9687. Our stop loss will be placed at 1.9672. Our profit target is the previous resistance level, which is located at 1.9730. This was the previous high before the small downtrend movement.

Chart 25.4: Morning star 4. Morning Doji Star

This is a triple candlestick pattern similar to the evening doji star pattern. The main difference is in the location they are found. While the evening doji star is found after an uptrend, the morning doji star is located after a downtrend. The first candle has a black body, which is followed by a doji. The third candlestick is a large white body, which will cover at least 50% of the first candlestick. Trading the Morning Doji Star When we encounter this candlestick pattern, we can look to buy when the third candlestick closes. We will look to buy the opening price of the following candlestick. In the example in the chart 25.5, it will be 1.4528. Our stop loss can be placed at the low of the pattern at 1.4520. Our profit target will be at the previous resistance, which is at the previous high before the downtrend. In this case, our use of the MACD helps to confirm the morning doji star pattern. The MACD indicator was rising while the price was falling lower. This divergence warning helps to confirm a possible low and supports the morning doji star pat- tern. 5. Bullish Engulfing Pattern

Chart 25.5: Morning doji star This is the opposite of the bearish engulfing pattern. In this double candlestick pat- tern, the first is a small black body followed by a large white body. The second white body should completely engulf the first candlestick. Trading the Bullish Engulfing Pattern In chart 25.6, looking at the MACD, there was a bullish signal given by the indi- cator. When we encounter this pattern, we will look to buy the next candle once this pattern is confirmed. The MACD has already indicated a reversal to the upside just before this candlestick pattern. We will buy at 155.30, or as close to the open- ing of the next candle after the pattern is confirmed.

Our stop loss will be at 155.08, which is the lowest point just before the bullish engulfing pattern. For our profit target we will be looking to sell at the previous strong resistance. This resistance is currently located at 155.73. Chart 25.6: A bullish engulfing pattern

Double Bottom When we encounter a double bottom pattern, how do we trade this type of pattern? For the pattern itself, we will be looking for the second bottom to break its down- trend line. Once the downtrend line is broken, chances are the price is going to do a reversal. We can confirm this double bottom reversal by using a technical indicator as well. There are a couple of indicators we can use. One is the RSI, while another is the MACD. In the example on chart 25.7, we have chosen to use the MACD. The MACD and price are showing a divergence. While the price is making another low, the MACD did not register another low. This is a warning of a reversal around the corner. This helps to confirm the view of the double bottom of an impending reversal as well. When the downtrend line is broken, there is confirmation of a double bottom pattern and an impending reversal. Trading the Double Bottom Pattern In the chart 25.7, once the price crosses the downtrend line, we can look to buy at 155.42. Once we enter into a position, we can place a stop loss at the recent low, which is at 155.33. The main profit objective is the height of A to the low of the second bottom. The height is equal to 30 pips (155.63-155.33). This height is added to the breakout point to obtain the price target of 155.72 (155.42+0.30). Another alternative is to use 1.6 times the height. That would give us a price target of 155.90 (155.42+0.48).

Chart 25.7: Double bottom pattern Triple Bottom This pattern has an additional bottom when compared to the double bottom. For the pattern itself, we will be looking for the third bottom to break its downtrend line. Once the downtrend line is broken, there is a high chance that the price is going to do a reversal. We can confirm the triple bottom reversal by using the MACD indicator. The RSI indicator can be used as well to confirm the triple bottom pattern. On the chart 25.8, we have chosen to use the MACD.

We can see from the chart that the MACD and price are showing a divergence. While the price is making another low, the MACD did not register another low. This is a warning of a reversal around the corner. This helps to confirm the view of the triple bottom and an impending reversal. When the downtrend line is broken, there is confirmation of a triple bottom pattern and the reversal in progress. We will buy at the breakout of the trend line at 1.0163. Our stop loss will be at the triple bottom low of 1.0148. The price objective is 34 pips (1.0182-1.0148). That would give us a price target of 1.0197. In this case, the price falls short of its target, and after reaching a high of 1.0194, it starts to fall. Sometimes, the price will fall short of its target, and when that happens, we have to be alert and be prepared to get out.

Chart 25.8: Triple bottom pattern Inverse Head and Shoulder This is the opposite of the head and shoulder pattern. In this pattern, there are three bottoms, with the middle bottom being the lowest. This lowest bottom forms the head, with the left bottom being the shoulder, and the right bottom forming another shoulder. The neckline is drawn across the two highs of the lowest bottom.

Trading the Inverse Head and Shoulder Pattern In the chart 25.9, when the neckline at 208.50 gives way, it is time to buy. Once the price penetrates the neckline, the inverse head and shoulder pattern is confirmed. The stop loss for our entry will be placed at 207.90. Our profit target will be at 209.20. How do we arrive at 209.20? Remember, the price objective measurement for this pattern is from the head to the neckline. In this case, it is from 207.90 to 208.60. That gives us 70 pips. Now, take that 70 pips and add it to the breakout point at 208.50, and we arrive at 209.20. Chart 25.9: Head and shoulder pattern

123/ABC Pattern We talk about using this pattern at the end of an uptrend. This pattern can also be used at the end of a downtrend. Just to recap the ABC pattern…. After a downtrend, you get a rally from point A to B. After this AB rally, there is a correction of the AB rally. At this point, you think that the downtrend is over and that the next direction is upward. You think you will get the ABC pattern. You want to get into the market. You can use the Fibonacci Retracement ratio to determine the point at which you can get into the trend. For more information about the Fibonacci Retracement ratio, you can refer back to Chapter 2.3. Trading the 123/ABC Pattern In the chart 25.10, at point C, which is a 62% Retracement of the point A to point B rally, it is time to get into the market. That 62% point is at 97.40. You do not know where the Retracement will end; you can look to buy at 50% point as well. Our stop loss is placed at 97.10, the low of point A. Our profit target is set at 98.40. This is 1.6 times the distance of point A to point B.

Chart 25.10: The 123/ABC pattern in motion

PART 2.6 Sideways/ Range Pattern Many times, we will encounter this type of trading: a sideways movement leading to a breakout, as can be seen from the chart 26.1 . From 6 am to 2 pm, the price remained in a range of 40 pips for the currency pair USD/JPY. Just after 2 pm, the price started to move out of the sideways trading band. There was a breakout. When we encounter this type of situation, what can we use to forewarn us of an impending breakout? How do we know whether the sideways movement is ending and the breakout is coming? Chart 26.1: A sideways breakout in the USD/JPY

USING A TREND LINE TO DETERMINE THE BREAKOUT One of the simplest ways is to draw a support and resistance line on the chart as show in the diagram. Once there is a breakout, we will go in the direction of that break. We will try to sell as close to the breakout point as possible. There is no need to wait for the closing to confirm the breakout. Once a short position is entered at 108.60, we will need to place a stop loss. The stop loss can be placed at the opposite end of the sideways channel, which is just above the resistance line. For the profit objective, it can be equal to the height of the sideways channel. In this case that would be about 40 pips. A sideways channel breakout usually would move more than the height of the channel. Another way is to use 1.6 times the height of the channel. This point is illustrated in the second profit objective. That would give us about 60 pips. (1.6 × 40 pips).

Chart 26.2: Trading a sideways breakout When faced with this type of situation, we can use the MACD indicator to confirm the breakout is impending. Before the breakout occurs, usually the price will start to lose momentum within the sideways channel. The MACD indicator will help to confirm the loss of momentum. USING THE MACD INDICATOR Whenever we encounter a sideways channel, it is best to draw the support and resistance lines on the chart. After placing both the support and resistance line, we can add in the MACD indicator to confirm the loss of momentum and the

impending breakout direction. From the chart 26.3, we can see that the MACD had turned lower, below the zero line, even before the sideways channel support gave way. Chart 26.3: Sideways breakout with the MACD indicator In the chart 26.3, we inserted the MACD indicator with its default parameter as recommended by its creator. As you can see from the chart, the MACD indicator with its default parameter is kind of smooth and not showing much detail.

In the chart 26.4, we have shortened the parameter for the MACD to 5, 11, and 16. (16 or the original parameter of 9 does not have much of a difference.) As can be seen from the chart, with a shortened parameter for the MACD, we get more details from the MACD. When we are looking for details with the MACD, like divergence, it is better to use a faster parameter. If you are using the MACD and signal line for entry and exit, it is better to use the original parameter. Chart 26.4: Sideways breakout with a fast MACD Trading the Sideways Breakout With the Fast MACD In chart 26.5, a fast MACD is used and you see that we get more details, and in this case, it shows the loss of momentum better.

The MACD confirms the sell signal when the price breaks below the support line of the sideways channel. We will look to sell as close to the break as possible, around 108.60. The stop loss and profit objective is the same as in the chart 26.4 Basically, the MACD indicator is used to confirm the sideways channel breakout. Sometimes, there are false breaks, and when that false break occurs with a loss of momentum, it is a warning not to fall into that trap. When the sideways channel breaks and the MACD confirms the break, the chance of success is very much higher. ___________________________________________________________________ ___________________________________________________________________