Monday 21 December 2009
We recently recommended short positions at 163.50,
British Pound – Trouble Across the Pond. One thing no one can ever know is
the outcome for any given trade. Developing market activity will provide the
answer, as new price information becomes available.
Where can this market go? It could very well retest the 140 area, but if it
does, it will not happen in a straight line down.
As an aside, if anyone ever tells you that technical analysis is useless, you
can rest assured that person is incompetent/ignorant in the art of it. This
British Pound trade is a perfect illustration of how the proper application of a
chart(s) analysis draws from the best available source of reliable information,
the market itself. You will never see us use RSI, [Relative Strength Index],
MACD, Bollinger Bands, moving averages, et al. They are a past tense effort
to capture and define future market behavior.
The very notion is capturing and defining the future is absurd in itself. We are
always willing to acknowledge that a stopped clock is right twice a day, and with
consistency. The same cannot be said for mechanical tools, but people want a
holy grail, so the popularity of these applications will continue to have a
following.
Back to our notion of reality. Let us point out that most of the lines drawn on
our charts are a priori to future events. The daily British Pound charts will
illustrate this clearly.
Markets are dynamic and ever-changing. Be confident in knowing that there
are no cookie-cutter forms to apply for any market. There are tools that do
come in handy, but just as you cannot use a wrench when a hammer is needed,
one has to have an understanding of how markets work in order to know what
to use and when. Our tools are price, volume, lines to denote
support/resistance, and experience.
On the first chart, a gap is shown on the current Mar contract, when Dec was
the lead month at the time. We also will deal with the application and use of
trend channel lines. Let’s start with the gap.
A gap is formed [a space between the high of a bar and the higher low of the
next bar, or the low of a bar and a lower high on the next bar, in a down
market] when there is a sudden demand as buyers enter the market in an
overwhelming capacity that drives price higher. What we know about such areas
of demonstrated strength is that they will be defended. This gap was formed
in mid-October and becomes a potential source of information. We can expect
the 160 -160.90 area to be defended sometime in the future.
Next is the trend channel. It requires three points, a high, A, a low, B, and a
lower high, C, [the reverse in a up trend]. A straight line is drawn, connecting
the two highs and extending into the future, as a broken line. From point B, a
parallel line is drawn into the future, called a Reverse Trend Line, [RTL]. All we
need are these three pieces of market information to create the channel lines.
Why draw these lines?
The top line functions as potential resistance for rallies. The bottom line serves
as an oversold indicator, and it may act as support. Understand that these line
are just guides and not absolute points from which to take immediate action to
buy or sell. At times, they can work quite well. What is more important is to
watch HOW price reacts to them. It is the REACTION that conveys a market
message.
Fast forward to Friday 18 December and the second chart.
We are getting some valuable pieces of market information. Rally bar D tells
us that the attempt to get back to the upper channel failed to make it beyond
half way in the channel. When a rally fails to recover to a half-way retracement,
it tells us the market is weak. Bar D tried to go higher, but in the attempt,
there were no willing buyers to support the rally, and we know this by the position
of the close. It is about mid-range, indicating that sellers were present on the
top half…what one would expect in a weak market.
The next bar, second from the end, broke hard with ease of movement down.
This is where we went short at 163.50, [British Pound – Trouble Across the Pond,
mentioned above]. The low of that bar touches the RTL, alerting us to the
Pound being in an oversold condition. Remember, this line is just information,
a guide, a red flag to pay closer attention to market activity. Price can STAY in
an oversold condition, and it can become MORE OVERSOLD by trading under the
RTL, as happens. This is why we said to watch HOW price REACTS to these areas
and not to use them as absolute trading points, as many who misunderstand
technical analysis do.
Volume does increase, and the close is off the low so we know there was some
buying, most likely short-covering and not new long positions from strong hands.
As a reminder, there was that gap which formed back in mid-October, and we
said the information it gave us was to expect the 160 -160.90 area to be
defended because it is here that new buying came in, at that time. You can
see that the RTL also goes through the same price area. One indicator can be
good; two or more separate indicators converging is even better. There are no
accidents, so take note.
The third chart is a 240 minute chart, [4 hours], used by professional Forex
traders, including us. Now we are getting into greater detail because of the
convergences, [alerts], just mentioned. The last wide range bar down from
162.50 to 160.43 touches the RTL, is in the gap area, and it has high volume.
The increased volume is third piece of important market information. To
repeat, high volume bars often denote a transfer of risk from strong to weak
hands.
We drew a horizontal line from the bottom of the bar D, just in case it gets
retested. If it does, we want to see HOW the market responds to it, after the
rally from that low. Two trading days later, we get an answer. There is a retest.
It becomes a probe lower, looking to see if there are any more sell-stops
under the market. The high volume tells us a lot of sell-stops were triggered,
[smart money covering while weak players who have missed the sell-off and want
in before they miss anymore, sell down here. Some things never change.]
The failed probe lower on high volume, at the gap support and RTL areas is
the market’s message that shorts are being covered. We were one of them, at
160.75, for a 275 pip gain. We had already taken partial profits on half
positions at 160.90, for a 260 pip gain, on the first decline to the RTL, just to
reduce risk exposure by locking in some profits.
The last chart is a 60 minute chart that amply illustrates the market activity we
have been describing. Art work is always helpful. Look at the large bar down,
6th from the end, and note the volume. The clincher is the next bar, 5th from
the end. It has equal volume to the previous sell-off bar, but this one is much
smaller. Why is it smaller? Because buyers, [those covering shorts] were in the
market in a big way at support, [as we have defined it], and the buying activity
was much greater than the selling activity which kept the bar from extending
lower. Those two bars were the culmination to the selling effort down from the
164.00 failed rally high, two days earlier.
This is how one reads market activity, and it shows how the market acts as a
reliable guide. Not a bad trade, but we cannot take a lot of credit because we
missed the sell from the 165 and higher level, after price failed at 167 on 3
December. Not all market reads are this “easy,” but when we can harmonize
with the present tense developing market activity, risks are less and profit
potential is greater.
Now you can see why anyone who says technical analysis does not work simply
does not know HOW it works. On to the next trade. May it be as clear and as
profitable as this one. In fact, the next trade may soon be in the British Pound,
for this market is still going lower.
We have a free two week trial subscription for those interested. Visit
http://www.edgetraderplus.com/, and click on the link half way down the page.
Cheers!
