range Archives - Algorithmic and Mechanical Forex Strategies

Ground Rules for Day Trading

January 28, 2016 by Lior Alkalay 19 Comments

Day trading is challenging. Don’t let anyone tell you otherwise. The odds are stacked against you and the risks of loss seemingly lurks at every turn. That’s why it’s important to understand some ground rules about day trading. The rules are there so that you can safely swim with the sharks.

Range is Key for Day Trading

One of the most common mistakes with day trading is failing to identify the daily range. Say you’re planning to take a long on the EUR/USD. However, the pair’s already moved above its average daily range. What might be the result? Your trade could be doomed as the market tends to gravitate into its average range.

When you trade for a few hours most of the signals you count on are a few hours old. This means, essentially, that the signals are naturally soft and fluid. Markets, especially on an intraday interval, tend to gravitate towards its range. Thus fluid signals tend to be much less reliable.

Knowing the range of the interlay trade can lower your risk of loss. Moreover, used in your favor, it could also improve your gains.

How to identify the range?

There are many techniques to identify the true range, including the Moving Standard Deviation or Bollinger Bands. However, those techniques tend to be more effective on swing trading. When day trading, I always recommend starting with what I call the top to bottom approach.

That is a method to identify your support and resistance levels in higher intervals, say, daily. Daily is actually ideal because it’s two levels up, compared to just hourly. Then you apply those levels on an hourly trade. What you get are solid levels you can count on rather than the fluid hourly support levels.

Down to Practice

This is a chart we used to identify the daily range. Now, we drill down into our desired interval. In this chart it’s the hourly interval, where we can get reliable resistance and support levels for either shorts or longs.

Source: esignal

Be in and Out Quickly

You should never stay in a trade longer than you have to; that’s clear and common sense. This method can be more forgiving in longer duration trades, e.g., multi days to several weeks. However, in day trading, when trades are counted by the minute, then every minute counts.

Spend too long at a trade and there can be dire consequences. The market that is already less reliable at such low intervals could turn against you. And the chances this could occur continue to grow the longer your trade is open. Hence, you should always concentrate on minimizing the time your trade is open while maintaining a worthwhile profit.

Down to Practice

How do you implement this rule in real day trading? You make sure your limit per trade is much smaller than the daily range. Why? As you approach the daily resistance/support level, the odds start to turn against you. There is a greater likelihood that the market will turn around before your position has reached its “full potential.”

Trade small and target prices that are well within the daily range. That way, you improve your chance of hitting that “home run” and profiting from your position.

Beware the Trend

Of course, we’re all familiar with the old adage “the trend is your friend.” Well, to that I say if the trend’s a friend then who needs enemies? There’s a rule of thumb for day trading. If there’s a bullish long term trend (i.e. several weeks) and you’re trading a short then beware. The market will have a tendency to unexpectedly surge higher and move against you.

Implementation

Now, some day traders may simply avoid taking shorts in just such a scenario. Yet that doesn’t have to be the case. Instead, you might just take trades with significantly lower leverage. By doing so you balance out the risk associated with trading against the long term trend.

The Ultimate Signal for Range Bound Trading

August 19, 2015 by Lior Alkalay 6 Comments

How does one identify that a range bound opportunity is descending upon us? We all know the trading signals for identifying trends and trend breaks, but how about those that identify a range bound? While most of us focus on riding the next trend that may not be where the next opportunity lies.

That might be in a range bound, where it’s easy to figure where the pair will move lower or higher. Of course, we all know what a range bound looks like in the charts. The problem is once we identify it as such, it might be too late. Many of the range bound trends become apparent only in retrospect, when the pattern crystallizes. But there is some good news. Just like tools that identify trends and trend breaks, there are effective tools for identifying the approach of a range bound.

Range Bound and Moving Standard Deviation

The single most evident quality of range bound is, quite simply, falling volatility or Standard Deviation. As Standard Deviation falls, the pair has smaller fluctuations and therefore is “bound” within a range. Likewise, when Standard Deviation is low we are stuck in a range.

If we can time Standard Deviation (and we can), we can know when it’s about to fall. If it is about to fall then we are heading to a range bound and can adjust our strategy accordingly. Moving Standard Deviation is a measure of the change of Standard Deviation through time. And it is exactly designed for our specific case and thus makes it the ultimate tool to time an upcoming range bound. Here’s how you do that:

Source: e-signal

In the chart above, we have the Moving Standard Deviation or MSD running (at the bottom). It is evident that MSD tends to top out after surpassing the 80% level while it tends to bounce back after falling below 20%.

In part A and C, you can clearly see that as MSD topped out above 80% the pair became less volatile and then moved into a range. On the flip side, when MSD moved below 20%, we can expect the range bound to end and the trend to continue.

Validate the Range

First Validation: If the pair had been surging when the MSD surpassed the 80 level, that’s your high band of the range. On the other end, if the pair had been sliding when the 80 was reached, that’s your low. Whatever high or low was reached during the time the MSD hit above 80 that’s your first confirmation of the range you will be getting.

Second Validation: The confirmation of the other band of the range will present itself as a candle with a needle, rather shortly after.

A Few Rules of Thumb

MSD 20 – Exit Immediately: Regardless of direction in your range bound trade (long/short) or time elapsed since the 80 level signaled the range bound, be wary. If the MSD falls below 20 get ready to terminate your trade, because the trend is about to resume and your range might be over. Although it’s not always immediate, it’s better to take precaution rather than lose your gains by ignoring the below 20 signal.

MSD is Only Good for Range: That might sound tricky. As we just stated, the MSD will always fall below 20 before the trend resumes. You’ll know when to exit your range bound trade and be able to cap your risk of loss. But many times MSD will fall below 20 and the trend won’t immediately resume. Thus, don’t use the MSD to predict the opposite of a range bound; that is, to predict the trend. There are different tools for identifying when a trend is about to re-emerge.

Range Bound Cycles: Finally, as you can see in the chart, in the long run the cycles of range bound vs trending tend to be more or less the same length. That is always something to keep in mind. Although the MSD will be your mark to exit/enter the range, timing your cycles of range is always useful to let you know how much more time might be left in that lucrative range bound trend you are taking.

Identifying a Trend Change

February 19, 2015 by Richard Krivo 7 Comments

One of the questions most often asked of me is how, as a trader, do you know the trend has changed. While it is definitely an important question, the answer is also one of the most elusive – and the answer is by no means clear cut.

Let’s take a look at a historical Daily chart of the AUDUSD currency pair below…

The last candle on the left of this chart is dated December 15, 2011. This is when the uptrend depicted on the chart began. We can see that the uptrend consisted of price making higher highs and higher lows and breaking through the significant resistance level presented by the 200 SMA. Also, during the uptrend the AUD was one of the strongest currencies and the USD was one of the weakest.

When all is said and done regarding the uptrend, price reached its highest point on February 29, 2012. This bullish move to the upside lasted about two and one-half months and was comprised of roughly 1,000 pips.

So when did the downtrend begin?

To answer that, let’s look at the first range identified on the chart.

Oftentimes, when an uptrend comes to a halt, price action will trade in a range consolidating for a period of time. The upward trend “stalls” and the pair just bides its time until the market decides how the pair will continue to move over going forward.

In hindsight, we can see that when price broke out of that rectangle to the downside for the first time, THAT was the official beginning of the downtrend. However, since none of us possess that infallible crystal ball, no one knew that this was the end of the uptrend and the beginning of a prolonged downtrend. Only the passage of time will provide us with that answer.

As traders, what do we need to see that indicates a growing potential that a trend change is happening and is likely to continue?

Let’s reverse engineer what we saw happening in the uptrend. If we look for the opposite of an uptrend we should be looking at a downtrend.

Since higher highs and higher lows make an uptrend, than lower highs and lower lows will make a downtrend. In looking at the right hand side of the chart we can see that this in fact is taking place. The more this process of lower highs and lower lows continues, the greater the likelihood becomes that the trend will continue.

We also note that as this move to the downside continues, the AUD is becoming weaker and the USD is becoming stronger.

While at no point in this process is a trend change guaranteed, the more the move continues, the greater the chance becomes that a short term trend change will strengthen and continue to evolve into a long term trend change.

Let’s look at three areas that I monitor when considering whether or not a trend change has taken/is taking place.

1) If the pair continues to make lower highs and lower lows and take out levels of prior support as it moves down, the pair is building a downtrend. The longer that process continues, the more likely it is that there will be a trend change. So how long is longer? Again, there is no black and white answer. Aggressive traders will call the trend change earlier and start taking short positions sooner than will a conservative trader.

2) As price begins to move closer and closer to the 200 SMA, the closer it gets to it the more likely that we are looking at a potential trend change. Once it trades through the 200 SMA and closes below it, that is very compelling data that the trend has changed.

3) If the currency in the pair that has been the stronger currency has become the weaker currency in the pair and that change continues over time, that is pointing to the probability that we are looking at a trend change.

So while there is not much certainty in calling a trend change in the short term, the above three points are what I monitor to determine if a trend is continuing or losing momentum and ultimately changing its direction.

All the best and good trading,

Richard Krivo

RKrivoFX@gmail.com

@RKrivoFX

A Home On The Range

August 21, 2014 by Eddie Flower Leave a Comment

Trading ranges and range breakouts offer some of the most common and potentially most-profitable marketplace scenarios encountered by forex traders. Yet, many traders are unable to build a winning strategy to profit from trading price ranges and breakouts.

The secret to successful range trading lies in identifying trading ranges and breakouts as early as possible, and then trading them proactively before the herd comes in and drives the price too far in either direction.

By using the right tools, ranges and breakouts are fairly easy to spot and take advantage of. Ranges offer something for everyone: Range traders work to trade currencies while prices remain within the range, and breakout traders focus on entering positions when the currency pair’s price leaves the range.

Properly traded ranges can be very profitable – When breakouts occur, they can yield huge returns. Meanwhile, range-bound forex trading strategies offer a slow, steady way to accumulate gains.

Still, it’s critically important to trade carefully: The keys to success are to avoid trading false breakouts and corrections, manage risks appropriately, and keep the expectations realistic.

In this article, I’ll describe some ways to identify and confirm stable trading ranges, which can then be successfully exploited by mechanical trading systems using a wide variety of strategies.

What’s a trading range?

The term “range” refers to the difference between the high and low prices for a given currency pair during a given time-frame. Range is the price spread during the time-frame, and it also represents the volatility of the currency.

The more volatile a currency price is, the wider its range. Obviously, the longer the time-frame, the wider the observed price range. For mechanical trading systems, ranges are useful for determining technical support and resistance levels as well as setting entry and exit orders.

Likewise, range is a measure of risk – The wider the range, especially during short time-frames, the riskier the currency play. By choosing the right trading strategy and employing appropriate risk-management measures, a forex trader can harness the power of the range to achieve excellent gains.

A trading range or channel occurs when a forex price trades at or near the same price over a period of time. When the price eventually moves outside this range, it’s called a breakout.

Breakouts from a range

Breakouts indicate momentum, whether positive or negative, in the sense that the balance of power of “long” and “short” currency holders has shifted to the opposite side.

After a breakout, the price may either continue to move away from the range, usually very sharply up or down, or else the price may return back inside the range, signaling a false or failed breakout.

Breakout trading strategies work to capture the gains from pent-up buying or selling pressure that can explode when prices move outside their typical ranges.

It’s easy to see a breakout after it has already happened, yet the challenge for traders and mechanical systems is to identify and act on the true breakouts while avoiding the false or failed ones.

Trading systems must effectively manage entries into false breakouts, since they’re so common. After entering a trade, the price may rise quickly before suddenly retreating back toward or into the range. Successful systems choose only the most likely winning trades.

It’s important to keep in mind that about fifty percent of all breakouts from ranges will retrace all the way back to the breakout point before once again resuming their desired moves.

A well-built system should be prepared to re-enter a new trade immediately after a loser, if the price overcomes its correction before again moving in the desired direction. And, during a correction toward the breakout point, the ideal trading system should at least harvest a small gain even after giving back most of the paper profits.

The solution for these issues is to use a winning combination of signal filters and confirming indicators to screen prospective trades before entering positions. In particular, tools and indicators based on the angle of the moving-average line, MACD, Average True Range (ATR) and Standard Deviation (SD) are very helpful for these tasks.

Breakout trading

As mentioned above, the most important concept to understand when trading range breakouts is that half of all forex breakouts fail. So, the most successful strategies are based on avoiding entering trades immediately. Instead, the system checks for confirmation before entering any trade.

The trading system should be programmed to wait until the price first retraces to the breakout point, then begins to move in the favorable direction again. This confirmation helps the trader reduce losses which inevitably occur during frequent retracements.

Psychologically, these retracements are even harder for the trader to tolerate when he or she is first stopped out, then the correction ends and the favorable move resumes without him or her aboard. So, it’s important that the trading system should only enter a trade once the price re-crosses the breakout point.

Of course, a retracement to the breakout level only happens about half the time. Still, the gains from confirmed breakouts can be spectacular and the confidence of success after waiting for confirmation is much higher.

Regardless of the individual strategy used to trade the breakout, one of the most common ways to set profit-targets is by using a target price that is equal to the width of the range either added or subtracted from the breakout price.

Range-bound trading

During trends, small traders can often trade profitably simply by following the trend and riding along with the herd of major institutional players. However, in a trendless, range-bound market, traders need a different group of strategies. Under such conditions, trend-following systems may generate many false signals for trades which ultimately lose.

Trading breakouts and trends can be profitable, yet major breakouts are relatively rare. A given currency price typically spends about half its time moving in a trend, and the other half in a range. Traders who ignore range-bound plays are missing half the fun and profits.

Forex traders who seek more opportunities often develop strategies for trading currencies while their prices are stuck in ranges or channels, where they may remain for long periods of time.

Range-bound trading strategies work by identifying the price ranges or channels in which currency prices are confined. These strategies are based on the prediction that prices will stay within the range.

In the most basic scenario, a mechanical trading system determines the nearby support and resistance levels, then it buys when the price touches the bottom (support) of the range, and sells when the price reaches the top (resistance) of the channel.

“Pure” range traders don’t care whether a currency price is going up or down, as long as it develops and stays within a trading range.

The range-trader’s underlying assumption is that prices will repeatedly return back to recent levels. The goal of mechanical range-trading systems is to harvest the gains from this repetitive cycle, while fine-tuning gains and losses by analyzing and responding to the latest market data.

Instead of merely finding the best entry points, range-trading systems should also be programmed to be “wrong as early as possible” and with carefully-adjusted position sizes so that the trading capital is preserved for subsequent trades that arise during the repetitive up-and-down price cycles that characterize forex ranges.

Detecting range-bound markets

Ideally, the trading system should be configured to spot the earliest stages of range-bound markets. Of course, it’s impossible to precisely predict winning trades every time, but the earliest recognition of a range allows the most flexible trading response.

Here’s the main rule for assessing a given market:

If the market isn’t obviously trending, it should be treated as a ranging market

With regard to technical indicators, when the chosen indicators stop showing clear signs of a distinct price trend, the trading system should assume the market is entering into a new range-bound period.

One of the easiest ways to spot a range-bound market is by checking the angle of a Moving Average (MA), generally by using a Simple Moving Average (SMA). For example, if the SMA is rising quickly, then the angle of its price line compared with the time axis will become steeper.

Likewise, if the angle is becoming lower, the trend is becoming weaker. If the angle is flat or near-zero, then the market is range-bound, or very sleepy.

Trading systems can be programmed with indicators built to compare the steepness of the angle of the current SMA against its “normal” steepness during different market periods. These indicators can be set to respond with various degrees of sensitivity to changes in the moving-average angles.

Another easy way to detect ranging markets is a Moving Average Convergence/Divergence (MACD) indicator. This type of tool works well in real time, especially when markets are volatile.

By adding two levels to the indicator – lower and upper horizontal lines below and above “0” on the MACD, trading systems can spot levels at which prices are most likely to consolidate.

In the chart below, the principal ranging zone is shown inside the green box. And, inside the box I’ve highlighted the ranging areas between the 0.05 and -0.05 levels. These are the tradable areas where the trading system detects a ranging market in real time.

As well, the MACD-based range-bound zone can be adjusted to values such as 0.03 and -0.03 or another value that the trading system determines to be appropriate for a given market. An expert advisor (EA) can help define the appropriate levels by examining historical levels in particular markets.

In any case, the MACD histogram hanging around the zero level indicates a ranging, tradable market.

Although naysayers may claim that this method doesn’t show the entire range until after the sideways movement has ended, your trading system doesn’t need to wait that long. When the MACD first enters the ranging zone, you’ll have plenty of warning that a range-bound market is about to occur.

Once the MACD enters the zone, the trading system can monitor the price and use additional confirmation tools to confirm that the range is still intact before trading. This MACD-based method can be very helpful in combination with other indicators.

Using Average True Range and Standard Deviation to spot trading ranges

As indicated earlier in this article, ATR and SD are helpful in highlighting trading ranges which can be exploited.

Shown in the EUR-USD chart below are two indicators, the 14-period Average True Range and the 14-period Standard Deviation, which can be used as tools to discover potential trading range areas.

In one indicator scenario, for example, when the 14 ATR is greater than the 14 SD, it indicates a ranging market. And, when the 14 ATR is less than the 14 SD, the market is trending.

From one perspective, the apparent logic behind this indicator is that the ATR shows the shorter-term daily volatility while the SD represents volatility over a longer period of time; although the market stops trending, the intraday volatility may stay the same, or slow down even more.

In another simple strategy, the trading system can simply monitor whether both ATR and SD are pointing upward. If so, the market is trending.

Also, savvy traders can build trend-strength indicators based on calculating a rate-of-change ratio between the current ATR and SD values using the desired time-frame. These indicators are useful for showing ranges as well as breakouts.

The usual default number of periods is 14, and Fibonacci-lovers often use 21. Still, as a rule, the shorter the trading system’s time-frame, the greater the number of periods should be.

If the ratio is increasing, it means the trend is becoming stronger. Or, if it’s dropping, it means the trend is weakening and will soon become either a range or a reversal. If the ratio is at the bottom, it indicates a ranging market.

In summary, there are a variety of ways for forex traders to determine whether a market is in a range, breaking out or trending.

Regardless of the strategy employed, traders can feel right “at home on the range” once they’re able to identify ranges and thus have more opportunities to trade them.

What’s your own trading style? Are you a range trader, breakout specialist, or trend-follower?