Analyzing The Trading Day - Part II

Well, I’m going to show you how to overcome that fear of losing a profit by explaining the nature of price moves in the Forex market.

We already know we don’t trade when news events are imminent. Just last week the Feds cut interest rates by ½ percent. It shocked the dollar, plunging it to an all time low against the Euro.

But what about normal price swings during the trading day. An interesting phenomenon often occurs. Take a look at the next picture. Prices were swinging wildly after the 5:30 AM (Pacific) report time.

Then around 7:30 the EMA’s crossed over, the red line now on top indicating a decline. We should only sell short this market. We could have caught a number of latitude lines.

But, more importantly, we would have felt confident trading the next three downswings.

Why?

Because each one declined more than the previous!

Chart 3

Take a look at P1 to P2. It crossed two latitude lines. P3 to P4 crossed three lines. And P5 to P6 was greater than the two previous swings.

This sort of thing happens all the time. As we get into the trading day the swings become progressively wider. Then, as the day begins to finish up the swings contract until they’re often just a straight line.

Perhaps I can best explain this by showing you a trade I made on a day I don’t usually trade.

Monday, September 3rd 2007, arrives bright and sunny here in Seattle. It’s Labor Day but the world-wide Forex market is open for business. I’m up at around 5:30 AM to check things out. I don’t expect much activity since it’s a holiday here in America.

But, I notice a nice trade shaping up on the 15 minute chart. It looks very similar to the charts we were looking at earlier. Notice how the moving averages are declining and have crossed over around 5 AM. The red line is now above the green line signaling we should only sell this market. Stochastics are also declining. Here’s what it looks like:

Chart 4

Looking at point one (P1) we see that the high point for that swing is 1.36455. (I usually use just the last three digits to do my computations, i.e. 45.5).

The low at point two (P2) is 1.36235 (23.5). If we subtract the low, 23.5, from the high, 45.5, we get 22.0. That’s how many “pips” this market has fallen.

Why is this important to know? Because price movements have a tendency to repeat themselves over and over as they trend up and down. In fact they tend to “overshoot” the next move in a busy market (and undershoot in a quiet market).

So, the next downswing should be at least 22 pips. (By the way, the previous downswing before P1 was 20 pips.)

Point three (P3) at 1.36356 (35.6) I figured was going to be the next high (we’ll get into why I believed this later).