Wednesday, March 27, 2013

How to Trade RSI Divergence?



Many traders look to the RSI traditionally for its overbought and oversold levels. While using these levels can be helpful to traders, they often overlook points of divergence that is also imbedded in RSI. Divergence is a potent tool that can spot potential market reversals by comparing indicator and market direction. Below we have an example of the EURUSD turning 738 pips after concluding a 1444 pip decline on a daily chart. Could RSI help us spot the turn? To find out, let’s learn more about traditional divergence.


The word divergence itself means to separate and that is exactly what we are looking for today. Typically RSI will follow price as the EURUSD declines so will the indicator. Divergence occurs when price splits from the indicator and they begin heading in two different directions. In the example below, we can again see our daily EURUSD chart with RSI doing just that.
To begin our analysis in a downtrend, we need to compare the standing lows on the graph. In a downtrend prices should be making lower lows and that is what the EURUSD does between the June 1st and July 24th lows. It is important to note the dates of these lows as we need to compare the RSI indicator at the same points. Marked on the chart below, we can see RSI making a series of higher lows. This is the divergence we are looking for! Once spotted traders can then employ the strategy of their choosing while looking for price to swing against the previous trend and break to higher highs.


It is important to note that indicators can stay overbought and oversold for long periods of time. As with any strategy traders should be looking to employ a stop to contain their risk. One method to consider in a downtrend is to employ a stop underneath the current swing low in price.

Monday, March 25, 2013

Why a Stop Needs to be in Place on Every Trade?



The difference between the entry and the protective stop is your risk and represents what you are willing to lose on the trade. 

Too many new traders use what they call a “mental stop”. 

They have a price level in mind where they would consider getting out if the market moves against them, but they do not enter it into the trading platform. Typically, when the market does move down to that price, instead of exiting, they “wait and see how the market will react”. 

If the loss becomes larger, then they decide that they will exit when the market moves back to their original mental stop level. As the market continues to move against them, intentions about getting out turn to hope about the market coming back before they receive a margin call. Many times, it is that margin call that determines their exit, not their own analysis. 

Sound familiar? 

I hope not, but this happens more than it needs to in the world of currency trading. You can avoid this by simply placing a protective stop in the market at the time of your entry. This means you have identified and limited your loss to an amount that you have determined to be acceptable. 

Always keep this mind: a losing trade does not mean that the trader doesn’t know how to trade. 

Moreover, losing trades cannot be avoided by not using protective stops. Instead we should limit those losses with the use of a protective stop. This way we can make sure we have protected our account balance and still have enough funds to take advantage of the next trading opportunity. 

We should judge our success by the results of a series of trades, not just one trade. Without identifying our risk and using a protective stop, we risk not having the funds to be around long enough to take advantage of a series of trading opportunities. 
 

Friday, March 22, 2013

How to Trade the Bearish Engulfing Pattern

One of the goals of a technical trader in the Forex market is to identify changes in the direction of price action. Candlesticks are a natural tool for this task as they give visual insight into market psychology and can suggest changes in sentiment. With this in mind, today we will focus on spotting and trading one of the markets most clear cut reversal signals using the bearish engulfing candle pattern.



What is a bearish engulfing pattern?
A bearish engulfing pattern is a candle pattern established at the end of an uptrend. Pictured above the pattern is created by interpreting the data of two completed candles. The first candle will depict the end of the established trend strength. It should be noted the size of this primary candle can vary and is not pertinent to the pattern itself. Dojis and other small candles are preferable though in this position, as they can reflect market indecision in the current trend.
The second candle in the pattern is the reversal signal. This candle is comprised of a long red candle creating fresh downward price momentum. Ideally the high of this candle should extend above the high of the previous candle followed by the creation of a new low. This strong downward movement reflects sellers overtaking buying strength, and often precedes a continued fall in price. The further this secondary candle declines, the stronger our signal is considered.




Bearish Engulfing in Trading
Once you are familiarized with identifying the bearish engulfing candle pattern it can then readily be applied to your trading. Above is an excellent example of the pattern in action on a daily EURUSD chart. From the January the 13th through February 24th the EURUSD rallied as much as 863 pips. This rally was concluded with the formation of a bearish engulfing pattern and this was our first opportunity to consider new selling opportunities prior to the subsequent 1444 pip price decline.
Traders had the option of considering a variety of entry mechanisms once this two candle pattern was concluded. While it is not uncommon to see traders execute on the pattern alone, it can also be used with an oscillator or breakout strategy to give further confirmation of the reversal. Most often the high of the bearish engulfing pattern can be used as an area of resistance. Regardless of the method chosen, traders using fresh entries may choose to place stop orders above this level in the event that a reversal fails and a higher high is made.