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happy trading 


Mr Phil Newton or on LinkedIn Phil Newton trader

Consistency Based Trading - Analysis (Part 2)

Pipsamundo's picture

I will attempt to build up the logic of the analysis element I use step-by-step leading to the analysis of Friday’s (24/04/09) GBPUSD chart.

Indicators

The main indicators I use on my charts to help identify price patterns where I would be interested in getting into a trade are as follows:

  • I use the 1-minute chart displaying candlesticks.
  • To identify trend direction, in the context of the daily flow and ebb of price, I use moving averages (30EMA, 60EMA, 240SMA, and 720SMA).
  • To identify potentially significant price areas (support and resistance) I primaryily use the MAs, supported by the 00 and 50 levels, daily pivots, previous day’s high and lows, and Fib levels.
  • I use a stochastic oscillator to identify potential areas that are overbought or oversold.
  • Traffic Lights – a simple custom indicator that goes green when I can go long, red when I can go short, and it’s white when it’s neither.  In this instance I can either stand aside or trade in the direction of the previous trade.

Edge

My edge is very simple to state and is as follows:

  • When price is trending up I look for a decline, and when down I look for a rally, that results is a small consolidation to a “potentially significant” price area, at this point I will place a trade in the direction of the prevailing trend

Testing

When I was developing this strategy I tested it using “Forex Tester” against the GBPUSD and EURJPY currency pairs using trading hours of 06:00 to 20:00, prior to trading this live.  If you’re not familiar with Forex Tester I would highly recommend it as it’s quite cheap and it allows you to load years of historic data and can quickly and easily test your ideas out.

System Rules

The rules of the system are as follows, and (I hope) will become more clearer when we go through the trade examples using the attached images, but please read the rules below first rather than jump ahead to the examples:

1.  Up Trend

  • The 30EMA is above the 240SMA. 
  • Price on close is above the 720SMA.

2.  Down Trend:

  • The 30EMA is below the 240SMA
  • Price on close is below the 720SMA.

3.  Potential Trend Transition or Range Period:

  • The criteria defining either an up-trend or down-trend, as in 1 or 2 above, are not satisfied.
  • In this period can stand aside or trade in the direction of the previous trend, i.e. if the trend was down then shorts are permitted, if the trend was up then longs are permitted.

4.  Trade Signal 1:

  • Define the direction in which you are looking to trade, i.e. long or short.
  • Place FIB between most significant high and low for down-trend, or between low and high for up-trend.
  • If there is a retracement of 50% or more AND a 3 candle or more consolidation AND the consolidation is near a “significant price level” AND stochastic is overbought for short or oversold for long, take the trade.

5.  Trade Signal 2 (strong trend):

  • When there has been a sudden and powerful movement either up or down, and price has traveled a long way from the 30EMA there is often a pullback to or near the 30EMA before price continues on.  Also, such trades do not normally provide a 50% or more FIB retracement and the stochastic will not fully retrace either.  However, these setups can be traded with a little practice, as follows:
  • There is a sudden movement from one trend direction to another, or sudden movement within the current trend, and races off moving a significant distance away from the 30EMA.
  • If there is a retracement to or near the 30EMA AND there is a 3 candle or more consolidation, take the trade in the direction of the trend.

6.      Stop and Exit

  • The stop is always fixed at 20 pips.
  • Simple Exit – set a limit to take profit at 20 pips.
  • Stochastic Exit – exit when stochastic enters oversold territory for short or overbought for a long.
  • Alternative Exit – look for where price may go to, for example if you sell at 1.4635 then a profit target of 1.4600 would make sense.  Alternatively you could set stop loss to entry point when 20 pips are in the bag and see where the trade goes to.

Trade Examples

As the system has been tested between 06:00 and 20:00 I’ve provided the analysis on yesterday’s (24/04/09) GBPUSD chart to illustrate the rules of the system.  Also, I’ve approached the day’s trading as though it was an exercise in building confidence and discipline, so to keep things simple all trades are 20 pip stop and 20 pip win placed at time of entry.  By doing this it gives you nothing to think about when you are in the trade - it simply wins or loses.

Firstly, just a quick note on the various coloured lines you will see on the chart:

  • 30EMA – yellow small dash line.
  • 60EMA – lilac/purple solid line.
  • 240SMA – sky blue large dash line.
  • 720SMA – white medium dash line.
  • Previous day and Overnight highs and lows are red small dash horizontal lines.
  • 00 numbers are white small dash lines.
  • 50 numbers are grey small dash lines.
  • Central pivot point is a heavy green line.
  • The indicator below the main screen is the stochastic (9,3,3).
  • The indicator at the bottom is the “Traffic Lights” which is just an easy visual reference of the trend rules.  It is green for up, red for down, and white for somewhere in between.
 

1.  Trade 1 (T1)

  • Refer to image number: 1
  • At 06:00 trend is down as traffic lights are red, it then goes white, so can still trade short.
  • Place Fibs from midnight high and 02:00 low, as price is contained within that range.
  • Within the 50% and 62% Fib is the 720SMA, which becomes the “significant price area.”
  • Price retraces up to the 720SMA, consolidates, stochastic is in oversold territory, and a short entry can be taken at 1.4680.
  • Result: win (20 pips).

 

2.  Trade 2 (T2)
  • Refer to image number: 2
  • The movement down after T1 doesn’t make a new low so Fibs remain in the same place as before.
  • Price retraces up to the 720SMA again and consolidates as with trade T1 so setup and entry are the same.
  • Result: win (20 pips).

 

3.  Trade 3 (T3)

  • Refer to image number: 3
  • The movement down after T2 makes a new low so Fibs are redrawn from the High made at T1 down to the new low at 08:45.
  • The area of interest above the 50% Fib is the 240SMA, but price doesn’t consolidate there instead it moves up to the 720SMA again.
  • Price consolidates just above 76% Fib, stochastic is oversold, and a short entry can be taken at 1.4670.
  • Result: win (20 pips).

 

4.  Trade 4 (T4)

  • Refer to image number: 4
  • The movement down after T3 makes a new low so Fibs are redrawn from the High made at T3 down to the new low at 09:40.
  • The area of interest above the 50% Fib is the 240SMA and 1.4650 price level.  Also, just below the 50% is the overnight low (1.4637).
  • Price consolidates just below the SMA240, the stochastic begins to move out of oversold territory, and a short entry can be taken at 1.4640.
  • Result: win (20 pips).

 

5.  Trade 5 (T5)

  • Refer to image number: 5
  • The movement down after T4 is followed by a sharp move up (no consolidation) then a move down again to a new low.  Fibs are therefore redrawn from the high after T4 to the low at 11:30.
  • The area of interest above the 50% Fib is the 240SMA, the central pivot point, and just above that the overnight low.
  • Price does move up and consolidates at the 240SMA and central pivot, stochastic is in oversold territory, and a short entry can be taken at 1.4610.
  • Result: win (20 pips).

 

6.  Trade 6 (T6)

  • Refer to image number: 6
  • The movement down after T5 makes a new low, and so  Fibs are redrawn from the high at T5 to the low at 12:55.
  • The area of interest above the 50% Fib is the 240SMA.
  • Price does move up and consolidates at the 240SMA, stochastic is in oversold territory, and a short entry can be taken at 1.4615.
  • Result: loss (20 pips).

 

7.  Trade 7 (T7)

  • Refer to image number: 7
  • This is an example of a Type 2 trade setup (see system rules above).
  • There is a very sharp movement up and the trend reverses – see indicator bar has turned green and there is only one white bar.
  • After price rockets up it pulls back and consolidates towards the 30EMA, stochastic looks to be crossing over, and a long entry can be taken at  1.4683.
  • Result: win (20 pips).

 

8.  Trade 8 (T8)

  • Refer to image number: 8
  • This is another example of a Type 2 trade setup (see system rules above).
  • As with the previous trade there is a pullback and consolidation at the 30EMA, also there is an added bit of confidence provided when taking Fibs from the low at 14:15 to the recent high, because the 62% Fib correlates with the 30EMA.
  • A long entry can be taken at 1.4732.
  • Result: win (20 pips).

 

9.  Trade 9 (T9)

  • Refer to image number: 9
  • After T8 price makes a new high at 15:02
  • Fibs can be taken from the low at T8 to the new high and the area of interest is the previous days high (1.4745) and 30EMA, however price does not consolidate there.  So the next area of interest is the 60MEA.
  • Price consolidates at the 100% Fib and stochastic is oversold, so an can take an entry at 1.4730.
  • Result: loss (20 pips).

 

10.  Trade 10 (T10)

  • Refer to image number: 10
  • After T9 price makes a new low so Fibs are redrawn from the low at T7 to the high made at 15:02.
  • The price area of interest below the 50% Fib is the 00 point, 1.4700, which corresponds to the 76% Fib level.
  • Price consolidates at this level, the stochastic starts to move out of oversold territory, and a long entry can be taken at 1.4702.
  • Result: win (20 pips).

 

11.  Trade 11 (T11)

  • Refer to image number: 11
  • Price doesn’t do much for an hour or so then consolidates at the 240EMA, the 1.4700 level, and the 76% Fib, and so a long entry can be taken at 1.4700.
  • Result: win (20 pips).

 

Trade 12 (T12)
  • Refer to image number: 12
  • After trade 11 the trend indicator goes white and the next significant area of interest, the 720SMA, is a good way away for a long, so I decide to stand aside.
  • At 19:12 the trend changes to down so I redraw Fibs from the high made at 19:02 to the low made at 19:12.
  • The price area of interest above the 50% is the 60EMA, but price blasts through that point, so  the next area of interest is the 240EMA, which is near the 1.4700 level.
  • Price does indeed consolidate at this level, which is near the 100% Fib, the stochastic goes overbought, and a short entry can be taken at 1.4695.
  • Result: win (20 pips).

 

Final Notes on Analysis Element

This is the analysis technique I currently use on a daily basis, in practice it isn’t difficult to use and hopefully you’ll find something in it of use or interest.  If nothing I hope it gives you some ideas for how to devise a “low-cost” analysis technique to help with the “trade placing” dilemma if that is the stage of development you are at.

On a practical note I do realise that the technique does have a potentially subjective or tricky technique, which is the Fib placement.  However, in practice I have found that because I am looking for a consolidation area the worst case is that I set the Fibs too far away and price does not retrace far enough to the 50% and so I simply miss the trade.  Also, as I mainly look for consolidations around the MAs, when I set a Fib up I'm looking or an MA to be between the 50% and 100% Fib levels - if there isn't anything of interest in that area then I wouldn't get into the trade.

Thanks for taking the time to read this blog and I’d love to hear from you if you’ve any thoughts, comments, or suggestions regarding this technique.  As promised my next blog entry will be the money management element that I’ve put together that goes hand-in-hand with this analysis method.

Cheers and consistent trading - Dave Search.

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