From the September 01, 2012 issue of Futures Magazine • Subscribe!

Trading forex with the trend

Trend development

When the Correction Zone holds, it says something about the buyers and sellers. Specifically:

  1. Traders, who bought on the break at 76.20, had little risk initially and now have great trade location, with the potential for a trend-like move. This allows them to manage their stop loss with little risk of capital. A logical stop would be on a move below the 50% (say, at 76.35) or even at breakeven (76.20). 
  2. Traders who missed the break higher at 76.20 can buy against the 38.2% retracement level at 76.505. They do not have as great an entry location, but they still have limited risk (a stop loss can be set below the 50% retracement at 76.35).
  3. Traders can assume the move higher is being supported by well-capitalized traders. Buyers took control on the break, held the 38.2% retracement and are not showing signs of relinquishing control.
  4. Sellers could not take back control. Even the seller at the 76.793 high should not feel confident with a short position. Shorts are now trading against the trend.
  5. When buyers are confident and can define and limit risk, they are more likely to buy. When sellers are scared and face the possibility of a trend move against them, they are likely to join the buying at some point. The combination creates another buying imbalance. 

This is what happened in the case of this USD/JPY move, and the market made another trend move to a new high at 77.177. 

Trends that are strong will tend to repeat this pattern. In “Continuing the trend” (below), the chart shows the next move higher. The correction from the top at 77.179 is a stronger move as the price breaks below the defined trendline (incidentally, on an economic release). However, when the price moves toward the Correction Zone (green area between 76.608 and 76.743), buyers emerge once again and force the market higher. 

A new, stronger leg to the upside is established as more traders realize the positive trend signals (rebounding quickly above the 38.2% and reestablishing support along the trendline). That trend move ends 106 pips higher at 77.802. 

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