Overbought/Oversold Defined

What Indicators Work Best at Predicting Overbought/Oversold?

This lesson will describe three separate indicators that I’ve personally used to determine when the market is overbought/oversold.  The first two indicators I will introduce will be RSI and Stochastic. They fall into the class of indicators known  as oscillators because they oscillate (fluctuate) between two extreme values. They are also part of a larger category of indicators known as leading indicators because they function in such a way that predicts future price action. They are the most popular and commonly used indicators for determining overbought/oversold conditions. At the end I will discuss what indicator I currently use now for determining these conditions, but let’s discuss the most popular methods first!

Trading using the RSI

What is the Stochastic Indicator?

The Stochastic is very similar to the RSI. It is an oscillator indicator and also part of the leading indicators category.  The Stochastic uses 2 lines that are similar to the MACD lines in the sense that one line is faster than the other. And just like with the RSI, the Stochastic is scaled from 0 to 100. When the Stochastic lines are above 80, then it means the market is overbought. When the Stochastic lines are below 20, then it means that the market is oversold. You could then pretty much employ the above RSI Rollercoaster strategy with this indicator as well, modifying it to include the crossovers of the red and blue lines, and you would probably have great success. But lets get to what I use to determine overbought/oversold conditions.

What are Envelopes (what indicator do I suggest)?

The method I use is to choose a timeframe (since the values change depending on the timeframe) and zoom out just enough to where you can see all of the candlesticks for at least a weeks worth of price action. For a lower timeframe you might only be able to include one day’s worth of candlesticks. Then physically count how many candlesticks actually close outside of your envelope bands with the current setting you are using. Then divide that number by the total number of candlesticks for that given period of time. You want to get the setting to where no more than 10% of the candlesticks actually close outside of the envelope bands. Therefore roughly 90% of the candlesticks do close within the bands. Now the next candlestick that closes outside of the bands represents an extreme level of price action thus predicting an overbought/oversold condition.

Think of envelopes as mini support and resistance lines that tell you how far the price action will stray away from your MA before it must return back towards it (at least an overwhelming majority of the time anyways). These are great areas to take your profit since they predict very well the limits to which any downward or upward move will stall out and probably move back towards the MA. Conversely, you can also consider them a great way to determine where to place a trade that’s in the opposite direction that the market is moving for some minor pip gains (30 to 60 pips as mentioned above).

I’ve found using envelopes fits my trading style and mentality the best. So as with any new trader who is trying to develop a trading strategy, always keep in mind that what works for some doesn’t mean it will also work for you. Also, I would never recommend you use more than one of these at the same time, because that would be both redundant and would make you more confused since often one indicator tells you it’s time to trade and the other says you should continue to wait. These indicators must be combined with other indicators such as support/resistance lines and pivot points in order to truly see the value they provide us retail traders. You will have far more success incorporating one of these indicators into your trading system, but first explore each one separately to decide what’s right for you.

1.    Take control of your own finances. No one wants to be a wage slave and trading forex is another way to supplement your income. The returns offered on most mutual funds, hedge funds, or managed funds is laughable usually around 5% annually. Unless you have millions to invest, that 5% doesn’t mean much until many years into the future. Most successful forex traders earn between 10% – 30% of their overall capitol each year.

2.   You can make money working only a few hours a day or week on your computer. You can trade from anywhere in the world where there is an internet connection.

3.    Start-up costs are low when compared with day trading stocks or futures. You can gain experience without risking your own money by using a free demo account. Online Forex brokers offer “mini” and “micro” trading accounts, some with a minimum account deposit of $300 or less.

4.    You can make money when the market is going up or down. Using something called technical analysis you decide which currency pairs are best to trade depending on what your analysis tells you. The many currency pairs trend very well, meaning they move in a specific predictable direction for an extended period of time making them easier to predict.

5.    Forex markets trade 24 hours a day. There is no waiting for the opening bell.

6.   Unlike the crooked and deceitful practices that are always rising out of the U.S. stock market, the forex market is the world’s largest market. No one can corner the market. With a trading volume of around $3.2 trillion dollars a day( Bank for International Settlements April 2007), no single entity can control the market for an extended period of time. The forex market is also the most liquid in the world. Traders can almost always open or close a position at a fair price.

7.    When trading stocks, there are over 40,000 stocks to choose from. In forex, there are 4 major currency pairs against which you will base most of you trading decisions on and you can choose one or two currency pairs and focus your analysis.

8.      No commissions. No clearing fees, no exchange fees, no government fees, no brokerage fees. Brokers are compensated for their services through something called the bid-ask spread.

9.      No middlemen. Spot currency trading eliminates the middlemen, and allows you to trade directly with the market responsible for the pricing on a particular currency pair.

10.    Anyone can do this and its been proven! In a very well known and documented study, a highly successful trader by the name of Richard Dennis recruited 14 people who he knew had little to no knowledge of trading and taught them his own trading methods in order to prove a point that traders aren’t born, they are made. A book was written and their success is well known in the forex community. The 6 most successful members of that original group are now controlling over $2 billion dollars of clients money and earned $500 million in the calendar year of 2008. I say all this to make the point that anyone can learn how to become a successful trader if they want it bad enough.

So read some lessons, ask lots of questions, use a demo account to apply what you learn, and keep track of your progress. The journey will have ups and downs but in the end be well worth the effort.

·    Bloomberg reports Germany may use KfW bank to buy Greek debt
·    EU says Greece needs another EUR 4 bln in budget cuts
·    Chicago PMI rises to 62.6 from 61.5; stronger than expected
·    Reuters: Long dollar position on IMM* largest since Lehman collapse
·    S&P 500 rises 0.1%
·    Oil up 1.51 to $79.68; gold little changed at $1116
·    AIG reports large loss, says may need more government aid
·    US Q4 GDP revised to +5.9% from 5.7%, consumer spending weak
·    University of Michigan consumer sentiment index falls to 73.6 from 74.4
·    US existing home sales fall 7.2% in January
·    S&P says US’s AAA rating “hanging in there”

EUR/USD traded with a cautious tone in early US trade, based mostly on continued  EU pressuring on Greece for deeper deficit cuts and on risk aversion after AIG said it may need more US funds. Once US economic data was out of the way prices began to recover somewhat, with the market also reacting a Bloomberg story which outlines a potential German plan to buy Greek debt. That, combined with month-end euro demand and short-covering sent EUR/USD up from the 1.3560 area to a high of 1.3683 shortly before the European close. Central banks were sellers into strength today once again, just as they were buyers of weakness early in the session. Rumor has it that stops continue to build in the 1.3700 area.

EUR/USD has had a real hard time closing above our major trendline, doing it just one time on Feb 16, making yesterday’s break an important development. We closed above the line on February 16 at the 1.3780/90’s level before plunging to close the next day at 1.3600. this is a trade setup that I went over in my posts for that same week back when I was still very sure of my dovish stance on the pair. Although that wasn’t much of a signal then, this more recent one truly is a warning sign for the bears, as is the fact that EUR/USD penetrated the 61.8% retracement of the 1.2448/1.5146 rally, that I also went over in earlier posts, twice in the last six sessions but has yet to close below it. As it stands now I am slightly bullish, but it doesn’t take much to turn that around, and this week will certainly be the most crucial week of trading in three weeks.

So here’s where I stand as a trader going forward. Since January I have argued that the US Dollar was likely to recover against the Euro and other key counterparts on extremely one-sided bearish positioning and sentiment. Looking back I wish conditions were still so easy to read now as they were back then, yet the tables are still clearly turned in the Dollar’s favor with the  CFTC Commitment of Traders data showing Non-Commercials at a record net-long the US currency against the Euro. This week’s fundamentals will be the deciding factor on which way this currency pair decides to go, and I doubt the ranges we’ve been seeing will continue after this coming week.

On Monday US Personal Income and Spending data comes out at 8:30 as well as the later-morning ISM Manufacturing survey at 10:00 am. If we see large disappointments in either one of those numbers it could potentially set the tone for the rest of the week’s trade. Recently we’ve had poor Consumer Confidence numbers painting a dreary picture for the future of domestic consumption, but spending and income numbers are forecast to show reasonable gains through the first month of 2010. Consensus expectations likewise point to reasonable strength in ISM Manufacturing data. Bear in mind though that lofty expectations beget disappointments and we could see considerable volatility surrounding said event risk.

After that we look for Wednesday’s key ADP Employment Change survey data (8:15 am) as well as the ISM Services report (9:15 am). The former is expected to show that private companies shed 10,000 jobs from Payrolls through the month of February—the best such result since January of 2008. As we continue to see smaller job loss numbers in the ADP report and official Nonfarm Payrolls data, it leaves hope that we may continue to see improvements, but any sizeable declines could easily derail expectations for future recovery. The ISM Services Employment Index will certainly be looked upon to shed some light on the state of the jobs market and help foreshadow what we may expect for Friday’s NFP numbers. Said index remains below the expansion/contraction 50.0 mark at 44.0, and it will be critical to see whether conditions improved for the all-important US Services sector.

Finally, as most everyone is aware, the US Nonfarm Payrolls report promises a great deal of volatility not only in the US Dollar, but major financial markets are likely to see sharp price moves on any especially surprising results.

It seems that financial markets are at somewhat of a crossroads. One could certainly make the case that steady improvements in economic data suggest that the worst is now past. On the other, heady gains in the S&P 500 and other key financial market risk barometers leave the door wide open for pullbacks. The week ahead should provide ample clarification on several key themes for the S&P 500, which is very highly-correlated with the US Dollar. Good luck to you!!!

Here are the news events to watch for effecting the EUR/USD.

Tuesday at 4;00 am,  German Ifo Business Climate comes out and generally has a decent effect on the market due to its large sample size (7,000) and historic correlation with German and wider Eurozone economic conditions.

Tuesday at 10:00 am, CB Consumer Confidence is released, a survey of about 5,000 households, measures the financial confidence of US citizens and would lend support to the idea of U.S. stability if the numbers come out at or above the forecasted 55. This has occurred three months in a row now since November so this report combined with the German Ifo Business Climate report could be a momentum builder to break this currency pair out of its’ ranges.

Wednesday at 10:00 am, several things are happening. Bernanke will be testifying and could drop one or two surprises so don’t be caught off guard that day. Also at the same time, U.S. new Home Sales data is released, so watch for that.

Thursday will see some lower level importance news coming out of the euro zone: German Unemployment Change and Consumer Confidence. But the big ones will be out of the U.S. with Core Durable Goods and Unemployment Claims both coming out at 8:30 am. Thursday’s have been some of the most active days we’ve seen so definitely still pay those reports some attention.

Friday at 5:00 am we’ll see CPI y/y and Core CPI y/y coming out of the euro zone. Forecasts and actual figures have been very close on both of these reports since November, so I would only watch for a big difference in numbers to occur in order to see these reports have any significant impact.

Friday at 10:00 am will be U.S. Existing Home Sales. With the U.S. tax credit coming to an end, look for some potential big differences in the forecasts and the actual numbers on this report as well.

When considering whether or not to become a forex trader you must first be able to resist the biggest temptation that exists when it comes to this profession: Greed. It’s the central focus of all the forex advertisements you’ll encounter, whether they are brokers, expert advisers, signal services, or mentoring services. The idea that you have just stumbled upon this new frontier of unbeatable risk to reward ratios and endless, easy income is a myth! So let me end it right here and now for you. YOU WILL NOT BECOME INSTANTLY RICH THROUGH FOREX. Actually, you will become overwhelmed, then frustrated, then tired, then discouraged, then apathetic, perhaps you’ll become hopeful, optimistic, and if you’re are lucky, eventually profitable over the long haul. But you won’t be rich overnight. You won’t make a million dollars in one, two or even three years, regardless of how much you have to invest. That is the reality of what you are entering into here. No one increases their account by 100% or even 50% annually, and if they claim to do so they are liars.

Let’s Begin

Now if you are still reading this beyond that entire unsympathetic, unapologetic, and downright sobering first paragraph, then perhaps you might just be able to commit to the discipline that real money management takes. Money management is the single most important aspect to a full time forex trader. By mastering money management, you will have the best possible chance at becoming the wealthy full-time retail forex trader that you always dreamed of being. Even with a fantastic strategy based on fundamental and technical analysis that is able to succeed 75% of the time, your profits will be gone in the long run, after one of those 25% draw down periods, if you don’t control your losses and hold onto your wins.

Now let me explain that I’ve read a lot of money management lessons in the past, and everyone of them bored me with terminology and long-winded examples that only made me feel lost and uninspired to follow through with, so I will not present one of those lessons. I’m not going to introduce you to every aspect of forex money management in order to overwhelm you with my knowledge and feel like I’ve written the Bible of money management here, because as a new trader, that’s not what you need right now. By simply using a demo account you will find out about such important, yet unbelievably uninteresting factors such as leverage, slippage, required margin and free margin, etc; everything that goes along with actual trading with your broker and their platform. You’ll learn faster through 10 minutes on a demo account than lengthy paragraphs and examples that I could provide you with here.

So You Want To Trade For A Living

Forex has got to be treated like your own business venture, not your fun pastime. It’s not a casino, a place to gamble away your capital as if you’re just here to catch that big win and then go away to a private island in the sun never to work again. Remember that’s not possible here. You wouldn’t carelessly invest business funds in side bets with an online casino, so don’t treat your MT4 platform as such either. Instead, prepare for possible dry spells where profits are slim or nonexistent. Just as if you owned your own business, you would be prepared for the challenges ahead and plan out your finances accordingly because you don’t want it to fail. You would never take your hard earned revenue and throw it away on a hunch or a gamble. You would constantly assess and adapt accordingly and become more strict and disciplined with the next week’s battle plans. So treat your forex profits the same. They are your lifeblood; they are what keep you in this, so whenever you go to place a trade, make sure that it is based off of sound and informed judgment. Whether you use the strategies that I teach here, or an adaptation of your own, always make sure you know why you are placing a trade and can back it up with fundamental and technical analysis. If you’re not sure what’s happing in the markets, then stay out. Not taking a position is still taking a position after all, it can still have a major effect on your account balance. And if you turn out to be wrong, then you can go back over what you used as part of your decision making process and adjust and adapt it for next time. Keeping a trading journal helps with this as well. This constant evaluation and adaptation is what molds you into a successful trader. You can’t reevaluate a hunch, but you can a strategy. Bottom line: know the why, when, and how much of each trading decision you ever make, or don’t make one at all.

Cut Your Losses Short, Let Your Profits Run

The real ‘meat and potatoes’ of money management boils down to one simple saying: Cut your losses short, and let your profits run. Let’s break down what that really means. Whenever you place a trade and see it become profitable, you should lock in that profit while still allowing it to mature and bring you more pips in the process. This is best done through the use of a trailing S/L. Always set your S/L, and always base that S/L off of at LEAST two forms of support/resistance whenever you enter a trade. Whether it’s an actual support/resistance line, a fib line, a trendline, a moving average, etc., base your S/L off of two solid forms of support/resistance plus your spread. Don’t forget the spread!

Now you might also think I’m going to say set a T/P, but that depends. If you are able to monitor your trades like any full-time forex trader, then a solid T/P is not always necessary, since you can trail your S/L once you get in profits. Now before I explain what that means, let me say that if you can’t monitor your trades at least hour by hour, then set a T/P based off of a pivot point, support/resistance line, fib level, or whatever indicators you use to determine price action levels of interest. Otherwise you will see profits become losses more often than you’d like.

Now in order to trail a S/L you must first determine what type of market conditions you are dealing with. If you are in a trending market, meaning price action is breaking into new lows or new highs, then you want to focus on how much momentum the trend has in order to determine which timeframe to use for trailing your S/L. The way I determine the amount of momentum a trend has is through the use of my unique alligator indicator (not to be confused with the Bill Williams one). The farther apart the red and blue MA’s are, the more momentum the trend has. In the case of a strong momentum trend, I would use the 1 hour chart, setting my S/L above/below the most recent candlestick wick plus the spread. This way you lock in profits in case the currency pair retraces quite a bit, in which case you can reenter a trade in the direction of the main trend after the retracement ends.

If you are in a ranging market, the trailing S/L is more complicated. I use the same red and blue MA’s of my alligator indicator, except apply them to my 15 minute chart. Here it takes experience to accurately gauge where support/resistance levels are, but the basic idea is the same as the above one. You want to set your S/L above or below the candlestick wick that you feel is the most recent support/resistance level for price action; the point at which if price action breaks through it you want to cash out and reassess your next reentry. I often use the red MA as my level of resistance, so therefore if I see price action break it on the 15 minute chart, then I’ll close the trade and take my profits. In ranging markets it’s difficult to gauge how far price action will go before it reverses, but usually anymore than 50 pips is doing really well.

Final Words

Now I feel like going on, but I also want to wrap things up. So let me add a few more words of wisdom. Never risk more than 2 to 3 % of your capital on any one trade, and no more than 5% or your total capital on all open positions. Those are the numbers I go by, although others will tell you to use even less.

Overall, money management is nothing new. It’s not complicated, you don’t have to really study up on it, just learn the basics for what is required to execute and close out a trade and what effect that has on your account balance in the long run through a demo account. Although a great strategy is essential too, it’s useless without money management. Good luck out there!

Trade with Confidence – 728×90 – Flash

Why are Fibonacci Levels so important?

Just as support/resistance and pivot point lines work so well because big banks and thousands of successful traders use them in their trading strategy each and everyday, the same goes for fib levels. It becomes a self-fulfilling prophecy when so many people see the same things and interpret them in similar ways. They work on any timeframe and with any commodity (oil, gold, stocks, futures, etc.).

Traders use these lines for two crucial reasons:

1. They are great at predicting where a retracement will likely end and
2. they are great at predicting where the price action will continue towards once the retracement period had ended. So in other words fib. levels tell you where you can jump back into a major trend when a currency pair starts retracing and where to take profits on that same trade once the pair resumes in the direction of the main trend.

How do fib lines do this?

Continuing along with the above two points, you can think of fib. levels as having two distinct functions: retracement levels and extension levels. One tells you key levels to watch for support/resistance during a retracement, the other tells you where you should set your T/P once the trend resumes its original course. Here’s a pic that shows how I used fib. lines to predict where the EUR/USD was headed after a brief retracement period.

But you don’t have to use them in-conjunction with each other. What I mean is that I use the retracement levels the most for predicting price levels worth re-entering in the direction of the main trend. Once I see a major trend has begun, I wait for a reversal in price action to take place (retracement), throw my retracement levels up on the charts, and then wait to see when price action meets resistance/support at a key fib level such as the 61.8 or the 50, and that’s where I re-enter.

How to draw fib levels

So let’s go over what that pic showed you. First in order to draw your retracement and extension lines you need a swing high and swing low point (points A and B in the picture). Now there’s no science behind picking these two points because everyone interprets their own charts a little differently, so you try to get as close as possible to what everyone else sees. How do you do that? One good method is to look for long wicks on the candle sticks because that usually indicates that a reversal is in the making.

Once you can clearly see that price action is in a true retracement you wait and see at what level does the price action encounters support (in a up trend) or resistance (in a down trend). Usually that level corresponds to the 38.2, 50, or the 61.8 retracement levels. Aggressive traders will jump into a position right at each one of those levels with their S/L 10 pips above it, then if that didn’t work out and price continues to the next retracement level, they will jump back in again. This explains why price action appears to be in a tug-of-war at certain times. At some point the retracement period will end and then price action will continue back in the direction of the trend and those aggressive traders will make up for lost pips. A conservative trader, like myself, will just wait and see where price action actually did finish retracing, and then jump in a little late but safer and with less stress, still knowing where the trend should meet support/resistance again based on the extension levels. I would rather go for 80% of the safe pips than try and snatch up the 10% to 20% of the pips that I miss out on through waiting. Remember in trading it’s not about how much you make, its how much you make AND can hold onto in the long run.

Rules for success when using fib lines

So what are the rules for where price action will go once we see its finished retracing and back to trending in the original direction again? Again, this is not an exact science here so you don’t want to just place your T/P right on one of these lines, as prices may not quite reach the line, since other traders are interpreting their own fib lines and acting accordingly too. But in general the rules go:

23.6 will continue on to 118 or 127

38.2 will continue on to 138.2

50 will continue on to somewhere in between 138.2 and 161.8 (use other indicators to know where)

61.8 will go to 161.8.

The big ones to always watch for are the 38.2, 50, and 61.8 retracement levels and their corresponding extension levels. I’d say about 75% of the time those levels are the ones that end up being hit.

Setting this up in MT4

So the last thing I need to do is tell you how to draw these lines within your MT4 platform. Sorry for those of you who use other platforms, but you still learned the bulk of the lesson. Now for certain reasons, MT4 designed their platform to have two separate fib tools, one for retracements and one for extensions. But as I just showed you, both of them are used in conjunction with the other, so I just combined them into the retracement tool so that I don’t have to draw the lines separately. Here’s how to do it.

Place a fib retracement on you graph (it’s the 7th button from the lower left row of your chart toolbars in MT4). Then go to Charts, then Objects, and then click on Objects List where you will see the “fibo line” as it’s listed as. Highlight it by clicking on it once, and then click on edit to your right. Once in there you can input levels of your own. Input the levels in this order:

Level _ Description
0 ————--0.0
.236 ———23.6
.382 ———38.2
.5 ————50
.618 ———61.8
.786 ———78.6
.86 ———-86
1 ————100
-0.18 ——-118
-0.27 ——-127
-0.382 —--138.2
-0.618 ——161.8
-1.618 ——261.8
-3.236 —--423.6

And in order to see the price at each fib level, click the Fibo level tab, then type next to the numbers in the description, %$. This will give you the corresponding price for each level you have selected.

Now whenever you go to draw a fib retracement you’ll have both the retracement lines and the extension lines drawn simultaneously!

There’s two more points I have to address here. The first is the “bonus” levels of 261.8 and 423.6. You’ll see these levels reached sometimes when applying fib’s on the lower timeframes and they are bonus rounds you could say for an extension. The rules you follow to know if the bonus round will happen is if you see the 161.8 level broken AND then retested as support/resistance AND it holds up as such. In that case your likely going to see the 261.8 target hit and if that holds up as support/resistance you can expect 423.6 to be reached. Lock in profits behind the 161.8 line just to be safe.

The second rule, and this is a real crucial one, is that fib’s are ALWAYS to be used in conjunction with other indicators. They are not a standalone kind of thing where you can base your decisions exclusively on these lines. You should have moving averages telling you what the main trend is doing, your own support/resistance lines as well as pivot points confirming retracement and extension levels, and whatever other indicators you specifically rely on to make decisions.

For more indicators that work well alongside fib levels: Moving Averages, Pivot Points, and Support/Resistance

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Also check out two of my videos that deal with how I use fib levels in my daily trading.

Finding Resistance Using Fibonacci

www.youtube.com/watch?v=orz1MOdIrRk

Fibonacci and Moving Averages

www.youtube.com/watch?v=ZDnJPvOil3s

Now you can think of pivot points as being another support/resistance line on your graph. But the difference with pivot points from your own support/resistance lines is that pivot points are predictive lines. To put it another way, the support/resistance lines you draw are based off of swings in price action that have already occurred where the price went up or down to a certain level and then sharply reversed its direction, so based off of that you can assume it will happen again at that same level. With pivot points you see lines drawn at the beginning of the week where price action is more than likely going to meet up with support or resistance, even though it hasn’t happened yet. These lines should not be considered too definate because price action might pass through the actual line or not even quite touch it. Here’s an example…

There are also daily pivots, although I wouldn’t place as much weight on them as weekly ones. That’s because news events and other technical indicators can nullify their importance. While I don’t typically put much importance on them, many other traders will say they use them quite a lot. If you’re using daily pivots there is also median, or mid way point, between the support and resistance lines indicated by a dotted line. I only use daily pivots whenever they line up with either a weekly pivot point or a support resistance line that I draw on my chart, since that adds more significance to that area of the price range as being a point of interest.

Now I’m going to skip how you calculate these lines because that gets done automatically by the indicator on your platform. Instead I want to give you the short and sweet rules for applying them to your own trading strategy.

There are 3 support and 3 resistance lines that you will see, referred to as S1, S2, S3, and R1, R2, and R3. But the most important ones are the weekly pivot (pink) S1 (blue) and R1 (red). Again these are not to be considered “lines in the sand” across which the price action shall not pass. Rather, they are very predictive of what regions to expect to see resistance or support begin to form. Look at this example from the EUR/USD.

Another thing to be aware of is the importance of the weekly pivot line. Most traders will agree that if price action begins the week above it then you should expect it to be a bullish week, and the reverse is true if price action starts the week out below it. But that’s VERY basic and not of much use since the fundamental forces in the markets can change all of that in one day. I only use pivot points as more of a suppliment to my other indicators, meaning if they agree with what my other indicators are telling me the I can enter a high probability trade and perhaps trade a larger lot size with a tighter stop loss. For example, if I see that price action has been moving up and is approaching not only R1 but also my envelope band as well, then I would enter a sell order as close as I can get to that level where the two lines intersect. Where you see your envelope bands and pivot points intersect, you can safely bet it’s a reversal coming (intersection of your horizontal pivot line and diagonal envelop line). That’s because two indicators are in agreement that price action is approaching an area of strong resistance. See image below.

Generally whenever a move starts at S1 it will go up to R1, or if it begins at R2 it travels down to S2. The medians are a little different because a move that starts at M1 usually ends at M3, M2 to M4. So with Medians you skip one M1 to M3. Generally start at a pivot, end at a pivot and start at a median, end at a median.

Also check out my video demonstrating how I use pivot points to trade the EUR/USD.

www.youtube.com/watch?v=9c_0SHaoMaU

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Understanding the economic calendar is central to being able to conduct fundamental analysis. Here’s an example of the calendar that is located on this website.

Since the market reacts to the most recent economic news events it is crucial that you begin each week of trading by taking a look at the upcoming news events for that week. As you look at the calendar you will see scheduled times of upcoming events as well as previous figures and forecasts for future ones. But the most basic thing you should take note of would be the impact of the news event symbolized in the above image as yellow, orange, and red symbols. Basically the red ones are the ones you watch for, the rest are less likely to move the markets in a major way although they can reinforce the bigger picture. The biggest mistake new traders make is not doing this and getting stopped out of a trade when a news event hits the airwaves that was predicted all along.

Things to watch out for with economic news.

1) The biggest news events: interest rate decisions, employment data, and GDP. But you should always check the significance indicator located by each news event since there are too many to mention for the purpose of this article.

2) Be aware that the forecast number is not always accurate, sometimes its WAY off! So lets say you have been following a huge uptrend with the Euro and you check in on the upcoming news events of the week and see that forecasts look great and so you continue to buy into the EUR/USD. If the real numbers come out worse than the forecast ones and you aren’t paying attention to the release, the uptrend that was once your grave train has now become a thing of the past. Bottom line is be aware of not only forecast numbers but actual ones as well. You can get these numbers as they’re released by visiting the economic calendar right after the event; actual data gets posted as soon as its available.

3) Sometimes the reaction to the event is not what you would expect. Trying to just trade off of the news events that are known to be big market movers is risky business and I would not advise doing so. It’s actually smarter to wait at least an hour after a news event before jumping into the market. This is due to many complicated factors that no retail trader can ever predict. Also the effect that a news event has on liquidity, the ability to process buy and sell orders immediately, is the biggest pitfall to trading the news. Brokers are not required to fill your orders exactly as they were quoted to you during news events and this is usually stated in their terms of service agreements. What that translates into is you could place an order at 1.5000 then see it actually went through at 1.5015, this is what is referred to as slippage and it hurts, especially if the high volatility that big news events create turns against you. When there’s more activity in one direction than normal the price action can skyrocket, so long story short don’t trade the news. If you truly want to still try and trade as close to the news release as possible I highly recommend reading my post regarding trading the news here.

4) Lastly, fundamental analysis is one part of predicting market trends, so you may find that sometimes the forex market does the opposite of what it should be doing. This is because technical analysis and psychology of the markets plays a large part in what takes place as well. As you become more expereinced in your trading history you’ll find its easier to read what’s taking place when this happens. But one short and simple rule to take away from this lesson would be this: If fundamentals and technicals agree, go for it with certainty. If fundamentals and technicals don’t agree, stick to the technicals but be cautious.

Non-Farm Payrolls gets released the first Friday of every month by the Bureau of Labor Statistics (BLS) of the US department of Labor. It is a compilation of a series of surveys conducted by the BLS which is an independent fact finding body hired by the federal government to collect, process, analyze, and disseminate crucial economic data to the public. The key thing to understand regarding the service they perform is that they maintain a high degree of accuracy, quality, and impartiality in both the subject matter and presentation (straight facts, no opinions).

Now there are a lot of ways that this data gets used to fundamentally analyze the US economy. Some examples are: knowing how many people have become unemployed, their ages, gender, race, how they lost their job, type of jobs lost, etc. This information gets digested by the big thinkers in government so that they can determine policy directions to influence the future course of the economy. What you as a trader should worry about are the numbers regarding monthly estimates of employment, hours, and earnings for the nation, states, and major cities.

Now keep in mind that a month to month analysis of this report is not necessarily relevant at face value, since you have to take into account seasonal variations that occur. Year after year there tends to be predictable flucuations around the holidays, vacations, and harvest time that get taken into account using a statistical procedure, but that’s just getting too deep into it. Just keep that in mind as you do your monthly checkup on this data.

What this data means to you as a trader is that it can predict things like inflation or deflation which effects interest rates and other Federal economic policies that in turn effect the forex markets drastically. Taking this report and trying to analyze it on your own would be an insurmountable chore, so I suggest seeking a breakdown of the findings from a trusted source. I also share crucial elements of this report here.

What do Moving Averages do?

To put it simply, they give us a much smoother/easier visual representation of what the price action has been doing. So instead of a chart that’s littered with candlesticks that are doing all sorts seemingly random moves up and down, we get a solid line which depicts the AVERAGE price action over the time period in question.

Check out this example:

So how do Moving Averages work?

To calculate a moving average you do the basic math involved with any basic average: take a group of numbers and add them up then divide them by the overall count of those numbers. In other words, for a 5 period moving average you would take the last 5 closing prices, add them up, and divide by 5. For a 10 period moving average you would take the closing price of the last 10 candles, add them up, and divide by… you guessed it 10.

But all this calculating gets done automatically by MT4, or whatever charting program you use, so lets get into how you use them to make money.

How do I trade using Moving Averages ?

Now I am going to have to get technical, so put your thinking caps on for this part and take your time.

There are two types of moving averages with their own advantages and disadvantages.

1) Simple moving averages are the most basic form of a moving average. This means that a simple moving average is a sum of of all candles for however many periods you request divided by the total count of those periods. In other words, SMA’s  are less susceptible to fakeouts or huge spikes in price action that usually occur around news events. But also be aware that this also means it is a slow indicator, lagging behind recent price moves which might have signaled an early breakout or end of a trend.

There is another type of moving average that works around this lagging problem:

2) Exponential Moving Averages are more complex because they involve a tweak to the calculation that puts more emphasis on the most recent price action and thus gives you a more up-to-date read on what the price is doing. What this translates to in trading is much less lag and thus quicker identification of early breakouts and trend reversals. On the same note it is important to know that 80% of all breakouts are false signals, so you should never consider this indicator as a stand alone method for identifying such changes in the market. EMA’s give you more of the noise in the market and more noise means more false signals.

So obviously both of these moving average functions have their own pros and cons that cannot be eliminated through some grand philosophical debate. And therefore one must arrive at the conclusion that both MA’s should be used together in some sort of cohesive harmony. The strategy I use to accomplish this harmony is with the Alligator which is in another lesson to avoid having too much material in this one, so check it out next.

One last but very crucial tool that can be applied to your moving averages to give you a great indication of when the price action will correct itself (move back towards the moving average line) are envelopes. Envelopes are also known as standard deviations from the moving average and are representative as such on your chart as parallel lines running along side your moving average. Here’s an example:

Envelopes are similar to Bollinger Bands in that you use them to determine the boundaries of the price action. By boundaries I mean the limits to an upward or downward push at which point the market is very likely going to reverse and go back towards the moving average. Think of envelopes as mini support and resistance lines that tell you how far the price action will stray away from your MA before it returns back towards it. These are great areas to take your profit since they predict very well the limits to which any downward or upward move will stall out and probably move back towards the MA. Conversely, you can also consider them a great way to determine where to place a trade that’s in the opposite direction that the market is moving for some minor pip gains. The essential part in all this is that you set your standard deviation settings so that the bands still catch or contain 90% of the candlestick bodies, otherwise they’re not as reliable at indicating overbought/oversold price action.

Trade with Confidence – 728×90 – Flash