Ebook Forex Money

Trade Book

2007-08-25T19:02:00.001-07:00

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Chapter 1. INTRODUCTION
1.1 MAIN WORLD FINANCIAL MARKETS
1.2 GENERAL FOREX MARKET DATA
Chapter 2. FUNDAMENTAL ANALYSIS
2.1 FACTORS INFLUENCING THE EXCHANGE RATE
2.2 GENERAL ECONOMICAL QUESTIONS AND BANKING
SYSTEM
• CENTRAL BANKS
• MONETARY UNITS
• THE TOTAL PRODUCT(Gross Domestic Product-GDP)
Chapter 3. TECHNICAL ANALYSIS
3.1 SUBSTANTIVE PROVISIONS
3.2 CLASSICAL METHODS
3.3 MATHEMATICAL METHODS
3.4 FIBONACCI NUMBERS AND ELLIOT WAVE THEORY
Chapter 4. STOCKJOBBING PSYCHOLOGY
4.1. TRADING RESULTS ANALYSIS
4.2 ASSOCIATION OF ALL GIVEN AND VARIOUS KINDS OF
ANALYSIS
4.3 MANAGEMENT OF THE CAPITAL AND TRADING
TACTICS
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Chapter 1. Introduction
1.1 MAIN WORLD FINANCIAL MARKETS
1. The market of the exchequer obligations (fixed incomes). The exchequer obligations act
as the goods in this market let out by corresponding state institutes of the countries, the
state exchequers and the Ministries of Finance. As a rule, the profitability depends on a
term of repayment and a discount rate valid in the country.
2. The precious metals market (commodities). The goods in this market are precious and
rare metals (silver, gold, platinum, a palladium, etc.). As it is known from the past,
practically all currencies have passed a stage of maintenance with that or another
precious metal, from silver (silver dollar) and up to gold maintenance. Investment of
funds of precious metals in the market allows to get profit, concerned to quotations of the
prices on precious metals, because precious metals always can "be exchanged" for money.
Investor always can place available precious metals in the banks and receive credit using
"metal" deposits for realization of the other purposes. At a rise in prices of precious
metals placed on deposit. The investor’s property grows and the incomes received from
the credit only increase his capital.
3. The share markets (Stocks). Stocks of the companies are the goods in this market. The
formation of the share markets has started in the beginning of the last century – the
market of stocks of the companies. The investment of funds in this segment of the
financial market is attractive to the investor for two reasons. Firstly, investing funds in
the stocks of this or another company, the investor acquires the right for reception of
share of the company profit – dividends, so to speak that usually make up to 10 % of the
invested funds sum. Secondly, the cost of the gained stocks can increase (at successful
development of the company). Thus, profitability from investments into stocks has two
components - the dividend and a difference between price of the stock and current price
of the stock. Trade in stocks is carried out at regional stock exchanges, such as, the New
York stock exchange, the Tokyo stock exchange, the Frankfurt stock exchange, the
London stock exchange, etc.
4. The international currency market FOREX (currency). The goods in this market are
currencies of various countries. It is the youngest and most roughly developing of all
segments of the financial markets. Profitableness of investment in this market depends on
change of currencies quotations. Attractiveness of investment in this market is concerned
to quickness of transaction fulfillment and additional bank service (crediting of
transactions with a credit leverage 1:100) also can make tens or even hundreds annual
interest rates.
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1.2. GENERAL FOREX MARKET DATA
At the end of 70th of the previous century after fixed rate system of national currencies in
relation to US dollar was canceled formation of currency FOREX market has started. (Foreign
Exchange Operations – set of operations on sale and purchase of foreign currency, and granting
of loans on concrete conditions, (the sum, the exchange rate, and the period with execution for
the certain date). The basic participants of the currency market are: commercial banks, currency
stock exchanges, the central banks, the firms carrying out the foreign trade operations,
investment funds, the broker companies and private persons. FOREX today is the global market
incorporated by a uniform communication network which opens on Monday morning in New
Zealand and gets closed on Friday night in the USA. FOREX trade is divided on some trading
sessions.
Operating time of FOREX (round the clock) GMT(Winter time)
Region City Open Time Close Time
ASIA TOKYO
HONK KONG
SINGAPOUR
23:00
01:00
01:00
08:00 – 09:00
09:00 – 10:00
09:00 – 10:00
EUROPE FRANFURT
LONDON
06:00
10:00
14:00 – 15:00
18:00 – 20:00
AMERICA NEW YORK
CHICAGO
13:00
14:00
20:00 – 21:00
21:00 – 22:00
PACIFIC VELLINGTONE
SYDNEY
21:00
22:00
05:00 – 06:00
06:00 – 07:00
The American and Asian sessions are the most aggressive, and great volume of
operations belongs to the European session. New Zealand and Australian sessions are the
quietest. The main currencies which are shared on the basic volume of all operations in the
FOREX market today are: Euro (EUR), Japanese Yen (JPY), Swiss franc (CHF) and English
Pound (GBP) and US dollar (USD). The daily volume of conversion operations in the world
makes about 2 billion US dollars. In the London market it was necessary about 32 % of turnover,
on a share of the markets of the USA - 20 %, Germany - 10 %. Operations with US dollar make
70 %. About 15 % volume in FOREX market today is on a share of electronic brokers. The
daytime volume of operations of the largest international banks (Deutsche Bank, Barclays Bank,
Union Bank of Switzerland, City Bank, Chase Manhattan Bank, Standard Chartered Bank)
reaches billions of dollars. (Spot) operations or current conversion operations are transactions of
currency sale and purchase of refer to as actual execution (value) which is carried out for the
second working day after the day the transaction was made. According to the data for 1998,
about 40 % of all Forex-activity fell at the Spot-market.
Typical transaction volumes in interbank trade make 10 million dollars, but due to margin
trade system, the output on the market is accessible also to the individuals with small capital. The
brokers rendering margin trade services, demand entering of the mortgaging deposit and enable
the client to make operations of currency sale and purchase for the sums, 40 - 50, sometimes a
100 times bigger, than plased deposit. The risk of losses is assigned to the client. The deposit
serves as the maintenance insuring the broker.
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Sources of the information about condition of the financial markets - systems of real time
delivering the data on quotations of currencies, and also financial and economic news from the
international agencies, REUTERS, DOW JONES, CQG, BLOOMBERG, TENFORE, etc.
Currency Rates
Currency Rate - is the price of monetary unit of one country, expressed in monetary units
of the other country, at the sale and purchase transactions. Such price can be established
proceeding from a parity of supply and demand of certain currency according to conditions of
the free market, or to be strictly regulated by decision of the government or its main financial
body, usually Central Bank.
Quotation - It is a cost of one currency unit (named base currency), expressed in terms of
another currency (named quoted or counter currency). The base currency enters the first, quoted -
the second, in designation of quoted currency pairs (for example, USD/CHF). The quotation will
consist of two figures. The first figure - (Bid) - the price client can sell the base currency at; the
second - (Ask or Offer) - the price client can buy the base currency for quoted. The difference
between these rates is known as (spread). The size of spread depends on the considered pair
currencies, from the sum of the transaction and from a condition of the market.
The minimal change of the quotation refers to - as (Point, Pip) item. Different tools
(currency pairs) are quoted with different accuracy, with different quantity of decimal signs in
the quotation. The majority of currencies quoted to within 0.0001, for example, yen and its crossrates
- to within 0.01. As the senior figures of the quotation (Big Figure) get changed slowly, the
quotation, as a rule, is given in abbreviated form: CHF 1.2380/84 for example, USD/CHF
1.2380/1.2384.
Example:
Quote: USD/CHF 1.2380/84 means, that
the client can sell dollars at the price - 1.2380 Swiss francs for 1 USD;
The client can buy dollars at the price - 1.2384 Swiss francs for 1 USD;
spread is 4 points;
base currency - USD, quoted - CHF.
quote GBP/USD 1.8430/33 meaning, that
the client can sell pounds at the price of 1.8430 dollars for 1 GBP;
the client can buy pounds at the price of 1.8433 dollars for 1 GBP;
spread is 3 poins;
base currency - GBP, quoted - USD.
The direct and inverse quotation The direct quotation - quantity of national
currency for one unit of foreign currency. The inverse quotation - quantity of a foreign currency
for national currency unit.
Use of the direct and inverse quotation has a historical substantiation. The basic world
reserve currency is American dollar therefore quotations for the majority of currencies are used
such as USD/JPY, USD/CHF, I.e. the dollar is base currency. However in the quotation of pound
sterling (GBP/USD) the pound is base currency, and dollar - quoted. The European currency of
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euro is also quoted to American dollar as a base currency (EUR/USD). It frequently should be
known in information systems currencies reduce USD, i.e. USD/CHF designate as CHF, and
GBP/USD designate as GBP.
Cross-countries-rates are parity between two currencies following from their rate in
relation to the third currency rate. Cross rates with US dollar are frequently used at world
market operations, as the US dollar is not only the basic reserve currency, but also currency of
the deal in the majority of currency transactions
Example: EUR/CHF = (USD/CHF) * (EUR/USD)
Spot-Rate – The currency price of one country, expressed in currency of the other country,
established at the moment the transaction made, under the currency swap condition by bankscontractors
for the second working day from the date of the transaction making.
The spot-rate reflects, how high the national currency rated at the moment of operation
carrying out outside following country
Basic rules of curreny pairs composing
1. EUR always represents itself as base currency.
2. GBP always represents itself as base currency, except for a case with EUR
3. JPY always represents itself as counter currency.
Cross rates (without USD)
EUR/USD EUR/GBP
GBP/USD EUR/CHF
USD/CHF EUR/JPY
USD/JPY GBP/CHF
USD/CAD GBP/JPY
AUD/USD
Margin Trade
As against currency transactions with real delivery or real exchange, the Participants of
FOREX, especially if they have a small capital, use trade with insurance deposit - margin or
leverage trade. Each operation at margin trade necessarily has two stages: purchase (sale) of
currency under one price and then obligatory sale of it (purchase) at another (or at the same) the
price. The first action is defined as opening of position, and the second - closing of position. The
real delivery of the currency does not occur at opening of a position, and the participant who has
opened a position, brings an insurance deposit serving as an indemnification of possible losses
guarantee. The insurance deposit comes back, and there is a calculation of the profit or losses,
which are usually equivalent to the size of insurance deposit after position closing. Thus the
deposit is frequently a hundred times less than that sum given the participant for use in this
trading operation. Operation at margin trade necessarily consists of two parts: position opening
and closing. For example, at the predicting rise in price (amplification) of yen in relation to
dollar we want to buy a cheaper yen for dollars now and to sell it back when it becomes more
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expensive. In this case operation will look as follows: position opening - purchase of yen, closing
a position - its sale. All the time the position is not closed, we have “an open position of yen ".
In the same way, if we suppose that yen will become cheaper (weak) in relation to dollar our
operation will consist of such steps: opening of a position - sale of yen, closing a position -
purchase of fallen in price yen. Thus, we have an opportunity to gain profit both at increase and
decrease of an exchange rate.
Absence of uniformity in the quotations of different currencies makes certain
inconveniences, especially for beginners. So, increase in a rate (movement of the chart upwards)
for pound and for euro in relation to dollar (GBPUSD, EURUSD), means a rise in price of these
currencies and downfall of dollar. And for franc, yen (USDCHF, USDJPY) means increase in
rate (movement of the chart upwards), fall of these currencies and rise of dollar. Generally,
during movement of the chart upwards the base currency raises in price, quoted currency
becomes cheaper.
For extraction of profit from the transaction it is necessary to buy cheaper (below at the
chart) and to sell more expansive (above at the chart). The sequence of these actions of value has
no necessity i.e. it is possible to sell all over again above, and then to buy below.
Deal Making
The making of transaction consists of several stages: quote request, quote reception,
submission of a command and confirmation of the transaction. It is necessary to specify
interesting pair of currency (tool) and the sum of the transaction at request. Thus it is not
necessary to inform the broker on the intentions - buy or sale. After reception of the quotation it
is necessary to give Buy or Sell command. The decision should be accepted beforehand as the
answer should be given within seconds - the market prices constantly change so the broker can
cancel the quotation and offer another price. Then the broker will confirm the transaction
conclusion and it already cannot be cancelled after the confirmation.
It is needed to specify the sum of base currency, and usually the transaction sum is multiple up to
100 000 units of base currency (1 Lot) at the Forex market.
Open position
The open position is a condition when the trader is under risk because when the change of the
exchange rates influences a condition of his account or, being expressed in different way when
he can get profit or loss because of change of the exchange rates. If the trader has leaded the
operation of currency purchases then they say he’s in a long position (long). Short position
(short) - if he sold.
Example:
Position opening. If the transaction Buy 100 000 GBP is made at the rate 1.8400 and
accordingly Sell 184 000 USD, that was the long position of pound (so to speak on
GBP/USD) and a short position of US dollar.
Position closing. If now you strike a Sell 100 000 GBP bargain, thus the position will be
closed. Thus the profit or loss will be received, depending on a closing rate.
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Profit or loss calculation If you have bought the goods (currency) at one price, then
have sold it at another one, then the profit or loss will make a difference between the price of sale
and purchase of the transaction multiplied by the sum of the transaction. Profit or loss=
Transaction sum * (Sell price – Buy price)
In a general view the formula of calculation of the profit and losses looks as follows:
Profit/Loss = N lots*100000*(Sell–Buy) – Nlots* Commission –N
lots*100000*Overnight*Ndays/365,
where N lots – quantity of lots 100 000each, used by trader
Sell – sell price of base currency
Buy – buy price of base currency
Spread – the commission raised by the dealing company
Overnight – difference in interest rates between base currency and counter currency for
operations Sell or Buy, depending on operations made by the trader. It is raised only in a case if
trader has not had time to close a position the same day. It can be positive (it is paid due to the
trader), and negative (is paid extra to the trader) Ndays – Quantity of days the trader has closed a
position within.
Possible profit or the loss (Unrealized P/L)
If you have an open position, you will have a necessity of possible profit or loss
calculation during concrete moments of time as rate constantly changes. While the position is not
closed, the profit or loss data is not finalized and refer to floating (possible or unrealized). If you
close your position during this moment at this rate you will receive such profit or loss. Same
formula should be used for calculation of possible profit or loss
You can carry out an output on FOREX only through the intermediary. The commission
house or the dealing center could be such intermediary. These organizations give you an
opportunity to use one of computer information systems such as Dow Jones Telerate, REUTERS
and have the allocated telephone or computer channel with the broker that gives you the
quotation of currency and you can make operations through. You also can directly work with the
commercial bank or the broker house. At the second variant you reduce the quantity of
intermediaries between you and FOREX that allows receiving more favorable operating
conditions. Even if you are so solvent and presume to buy and pay to yourself monthly services
of one of the information systems, the output on the active market participant (market-maker)
giving you the price for transactions is necessary for you either way.
The prices you see on the computer screen are the prices of real FOREX transactions. The
prices constantly change. Therefore you cannot simply call the broker and order operation under
the price convenient for you as this price can not suit him. Before you make a deal you request
for the price and can buy or sell only at the price given to you by broker. Firstly, do not forget
that you are a passive participant of the market and cannot establish the price. Secondly, the
broker will give you quotation poorly distinguished from what you see on the computer screen.
You should specify what operation we want to make - purchase or sale at the closing or opening
of a position. The commands Buy (to buy) or Sell (to sell) are used for this purpose
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Participants of FOREX
The participants of this market, first of all, are large commercial banks through which the
basic operations under the instruction of exporters and importers, investment institutes are
carried out, insurance and pension funds, hedgers and private investors. These banks also carry
out the operations in the interests due to own funds, thus volumes of daily operations in the large
banks reach billions of dollars, and the basic part of the profit is formed only due to speculative
operations with currency at some banks. Except for banks, the broker houses carrying out a role
of the intermediary between a plenty of banks, funds, commission houses, the dealing centers,
etc. Commercial banks and broker houses not only make operations on sale and purchase of
currency at the prices which are exposed by the other active participants, but also offer own
prices. Thus, they actively influence the process of pricing and a life of all market, therefore they
are called (market makers).
As against the active participants, the passive participants of the market cannot expose
own quotations and make currency purchase-sale under the prices offered by active participants
of the market. Passive participants of the market usually pursue following purposes: payment of
export-import contracts, foreign industrial investments, opening of branches abroad or creation
of joint ventures, tourism, gamble on a difference of rates, hedging of currency risks, etc. The
Central banks of the different countries come on FOREX, not only with the purpose of extraction
of the profit, as a rule. They usually do it with the purpose of stability check up, or correction of
an existing rate of the national currency. The correction of an existing rate of national currency
influences on the national economy condition. The central banks also come out on the currency
market through the commercial banks. Profit extraction is not the basic purpose of these banks,
but unprofitable operations do not involve them as well. The central banks of different countries
can carry out also the joint coordinated interventions. If the active participants make the
operations with the big sums of a few million dollars, the passive participants can use margin
trade. They have an opportunity to temporarily operate the capital, in one hundred times
exceeding their deposit. Such way of trade allows to take a part in work of the currency market
to fine investors with small capital and thus to receive significant profit. The structure of the
basic participants of the market testifies that this market is actively used by “the serious business
", for the serious purposes. That means not all the market participants use FOREX in speculative
purposes.
Chapter 2. FUNDAMENTAL ANALYSIS
2.1 THE FACTORS INFLUENCING THE EXCHANGE RATE
One of the most important and complicated components of currency dealing is an ability
to carry out the analysis of the market change tendencies and accordingly to foresee, what factors
will affect the exchange rates and how it may happen. There are the opportunities of fast profit
extraction, and the opposite - opportunities fast and substantial losses possible in the market
price movement. Therefore the correct forecasting of the market movements, estimation of those
or the other events, and also manipulation with gossips and expectations is a necessary
component of work of the broker or dealer and a pledge of his successful activity. There is a
multitude of factors influencing both all currency market as whole and separate currencies. There
are two basic ways of the market situation analysis - fundamental and technical ways. The first is
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engaged in estimation of situation from the point of view of a political, economic and financialcredit
policy. The second one is based on graphic research methods and the analysis based on
mathematical principles. There are various messages about currency-financial events in the
world studied within the framework of the fundamental analysis. The phenomena of political and
economical life both the separate countries, and the world community as a whole which can
influence the currency market development, the analysis is carried out, in exchange rates they
can result in what change. The important factor here is the information about work of stock
exchanges and the large companies such as market-makers, discount rates of the central banks,
an economic rate of the government, possible changes in a political life of the country, and also
every possible gossips and expectations. The fundamental analysis is one of the most
complicated parts and at the same time, one of key parts of work in the currency market. It’s
much more difficult to carry out the fundamental analysis than any other type of it because the
same factors render unequal value on the market in various conditions and may become
absolutely insignificant from deciding factors. It is necessary to know interrelation and mutual
influence of two various currencies, reflecting communications between the various states,
history of currencies development, to define cumulative result of those or the other economic
measures and to establish communication between absolutely different at first sight events.
Besides any primary and most formal rules, here is the greatest degree of operational experience
in the currency market required. The factors reflecting a national economical situation an
influencing currency rates are such:
• Parameters of economic growth (a total national product, volumes of
industrial production, etc.)
• The condition of trading balance, a degree of dependence on external sources
of raw material
• Growth of monetary weight in a home market
• The inflation rate and inflationary expectations
• The level of the interest rate
• Solvency of the country and trust to the national currency in the world market
• Speculative operations in currency market
• The of development of the other sectors of the world financial market degree,
for example a securities market competing to the currency market.
2.2 GENERAL ECONOMICAL QUESTIONS AND BANKING
SYSTEM
Central Banks
The Central Bank watches a rate of inflation in the country, a rate of national currency
and tries to adjust them by means of three basic interest rates.
11. The Discount Rate. The interest rate, Central Bank finances commercial banks at.
USA 1.75%
Japan 0.15%
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Euro zone 2.00%
Great Britain 4.75%
Switzerland 0-0.75%
Australia 5.25%
Canada 2.25%
The American and English rates are high, that’s why foreign investors show the big
interest to these.
2. The Rate – Repo rate. The interest rate used by the Central Bank in the operations
with commercial banks and other credit institutes at purchase (account) of the state exchequer
obligations. The Central Bank carries out regulation of the market of loan capitals. Fed Funds
(rate Repo USA).
3. The pawn rate - Lombard rate. The interest rate used by the Central Bank on the
security of the real estate, gold and values exchange at delivery of credits to commercial banks.
There is the business activity raising and inflation increasing at the reduction of the interest rates.
Decrease in interest rates leads to price reduction of national currency. Increase of the interest
rates leads to decrease in business activity, decrease in inflation and rise in price of national
currency. There is the method of influence a national currency rate remaining in modern
conditions. It is the practice of purchase and sale of foreign currency by the central banks, named
continues to currency intervention.
USA
Anerican Centrall Bank is called Federal Reserve System. The President – Alan
Greenspan. The decision to change the interest rate is getting made by FOMC – Federal Open
Market Committee, which session passes time in six weeks two days: Monday and Tuesday.
Financial Ministry USA - Treasure = TSY. The President – Lawrence Summerce. Usually, when
Summers speaks, the dollar rises in price; when Greenspan speaks, - the dollar falls.
GERMANY
German Central Bank – Bundes Bank. Session is carried out once in two weeks on
Thursdays in Frankfurt, but rate Repo may be changed every week on Wednesdays. The
President - Ernst Welteke. Bundes Bank is considered one of the most professional participants
of the market.
UK
The central bank of the Great Britain – Bank of England (BOE). The manager of the bank -
George (George). Usually the important messages under accepted decisions OPQ act at 15:30
GMT.
SWITZERLAND
The Central Bank of Switzerland – Swiss National Bank (SNB). The bank of Switzerland
is considered silent and cautious in the market. Watches closely a parity of rate EUR/CHF
RSTUVWX Y ZY[\Y] ^UV_`[SZYXaX bS[cY[ Z ]SXUcd 1.1400 eX 1.1480 U fV\VcTV cVZYXWgYTh
iTc]f, T e[WVV eX ]SXUcd 1.1580 U fV\VcTV RXZWVe]jkVaX \[Z[from a level 1.1400 up to
1.1480 within several minutes, and further up to a level 1.1580 within the next hour
JAPAN
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The central bank of Japan – Bank of Japan (BOJ). Differs from the other Central Banks
with unexpected and very powerful currency interventions.
Alongside with the central banks in the currency market, the broker firms also function,
working with concrete bank and represent itself as intermediaries between currency seller and
buyer. It is possible to attribute anonymity to the certain advantages of work via broker at
fulfillment of transactions such as a continuity of process of the quotation, and an opportunity to
offer own prices. There was a change of trade character with transferring accent on change of
trade promptness last decades such as: significant growth of transactions. The execution of those
occurs in the future. All this has led, on the one hand, to the raised susceptibility of the currency
market, to tactical changes and to substantial growth of currency fluctuations, and on the other
hand, to growth of opportunities of highly effective investment. There is a wide circulation
alongside with the operations on purchase and sale of currency gotten by the operations with
derivative financial tools - financial futures and options. Examples of such stock exchanges are:
the London International Stock exchange of Financial Futures (London International Financial
Futures Exchange - LIFFE), (European Options Exchange - EOE), the German Urgent Stock
exchange in Frankfurt (Deutsche Terminboerse - DTB), the Singapore Stock exchange
(Singapore International Monetary Exchange - SIMEX) (Sydney Futures Exchange - SFE) and
the Stock exchange of Urgent Trade in Sydney.
MonetaryUnits
90, 91, 92, 93 – MONEY SUPPLY.
90 - Cash in circulation, banknotes and coins;
91 = 90 + Funds for settlement and current accounts in the banks, traveler’s cheques;
92 = 91 + Fixed deposits in the banks;
93 = 92 + Valuable state papers.
The accelerated growth of monetary weight, both in cash, and in the non-cash form,
renders lowering influence a rate of national currency. The consumer price index (Consumer
Price Index - CPI) is a retail price index. The price index of the manufacturer (Producer Price
Index - PPI) is an index of wholesale prices. When those indexes run high the national currency
rate runs high as well. It is considered allowable growth of these indexes up to 3 % a year.
Gross Domestic Product – GDP
The economical situation gets up and down as same as GDP . Optimal change is up to
3% a year. If it is higher then it brings an inverse reaction. Then it is necessary to enter the raised
rates that will cause rise in price of national currency. CPI and PPI once a month M/M are
considered. GDP - quarterly Q/Q also it is recalculated for a year Y/Y.
It is necessary to pay attention to the following parameters at the analysis of a developed
situation in the market: Incomes and charges of citizens
Personal Income
Sensation of the consumer, readiness of the person to spend money (Consumer Sentiment)
Construction Spending
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Hosing Starts
Building Permits
New Houses Sales
Existing Houses Sales
Unemployment Rate – It is calculated once a month. At increasing in a parameter the
national currency becomes cheaper. The primary reference on unemployment (Imital
Claims).
Continued reference (Continuing Claims).
Retail trade (Retail Sales) – When the commodity circulation gets better, currency gets
stronger
Orders of dealers for the durable goods (Durable Goods).
All the above shown information is usually broadcasted at 19:30 and 21:30 GMT
(Reuters,CQG).
JAPAN
Fiscal year of Japan comes to the end on March, 31. By the end of the year, a plenty of
foreign currency in yens is converted for leading balances that leads to to its rise in price. Many
insurance companies of Japan are the largest players in the market: USD/JPY, USD/EUR,
EUR/JPY, SFR/JPY, GBP/JPY. The big problems in Japan are caused with the growing old
population. Deduction of the small interest rate for many years has caused a skew in bank sphere,
But, nevertheless, banks of Japan remain the largest world banks. Strengthening of South-East
economy for the long term will give chance to yen to become the basic currency for the Asian
region.
SWITZERLAND
Switzerland is not going to enter the European Community, thus, emphasizing the
independence. Appeal of CHF remains very high. But there are some problems associated to
nazi gold which put reputation of large Swiss banks under doubt.
UK
Presence of high interest rates in England defines the big interest of world speculators
that affects economic parameters as a whole. England - the conventional world financial center,
the main offices of the largest investment giants are located here.Thre is a v very rigid legislation
function regulating financial activity of the companies, banks and stock exchanges operates inn
territory of the country.
Chapter 3. TECHNICAL ANALYSIS
3.1 SUBSTANTIVE PROVISIONS
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TECHNICAL ANALYSIS – The research of the market dynamics by means of charts, as
the purpose of forecasting the future direction of the price movement. The «dynamics of the
market» term includes three basic sources of the information, at the disposal technical analytics,
namely: the price, volume and open interest (with reference to the future markets). As the price
we shall understand "thermodynamic" balance between a supply and demand on the following
currency. And does not matter, what this balance is caused with: estimations of macroeconomic
parameters, recommendations of experts, psychology of currency traders or any other
circumstances. As well as any other scientific discipline, the set of axioms makes basis of
methods of the technical analysis:
The axiom 1 - Dynamics of the market takes everything into account. That means that any factor
influencing the price - political, economic and psychological - is taken beforehand into account
and reflected in dependence of the price on time. Therefore the analysis of the price charts is a
necessary condition for the forecasting.
The axiom 2 - The prices always move directive
The periods of growth and fall always alternate with each other so there is a tendency prevailing
inside each of them. And it is active till the market opposite direction movement begins.
The axiom 3 - History repeating. That is so because the human psychology in the basis is
constant. It is supposed, that if the certain types of the analysis worked in the past these will also
work quite successfully in the future as this work is based on stability of human mentality. In the
point of view of the technical analysis, the understanding of the future lays in studying the past
so to speak. Methods of the technical analysis are subdivided into two parts - classical methods,
and methods that basis strict mathematical laws lay in.
3.2 CLASSICAL METHODS
Movement Price Charts
It is possible to reveal the general laws of movement of the prices with the help of the
visual analysis of the train diagram of the price. Graphic dependences of the price on time are
called charts. There are a few types of price charts.
Line Charts
Each point of the line chart can represent a level of the price the following trading day
was closed or opened on. Or the average value of all price fluctuations for the certain period. By
virtue of the simplicity, the linear chart is convenient for using at early stages of studying of the
market and making of the trading plan.
14
(Bar Charts)
Way of the graphic analysis of the prices via of special objects - bars. The vertical line
between the highest and lowest prices of the considered period is carried out for building of bars.
There are the small strokes designating the price of opening and closing accordingly are
represented on the left and on the right. Histograms are useful with the representativity and help
to make the best forecasts via classical trend and reversal patterns.
(Candlesticks)
There is as same data, as for bars are used for candle construction. The candle is under
construction as follows: there is the rectangle named a body of a candle is drawn in an interval
between the prices of opening and closing. Vertical sticks from above and from below bodies
refer as shadows. Color of a candle body depends on a relative positioning of opening and
closing prices. If an opening price is higher than a closing price, is green (or painted over). In
another case the candle body is red (or unpainted).
The diagrams of the prices are under construction on various individual pieces of a time
scale. These pieces can have the most different values – from minimally possible (determined by
opportunities of all information-analytical system), up to sizes about hours, days, weeks and even
years. It is necessary to always commensurate scales of considered time intervals, and sizes of
individual pieces of an absciss scale analyzing charts. The scale of the price in different types of
the price charts also can be different - arithmetic or logarithmic. The logarithmic scale reflects
non absolute (as an arithmetic scale) and relative change of the price and can be useful at
drawing up of long-term schedules.
1rend analysis. The basic kinds of trends.
Three types of trends (tendencies) on a direction of the price movement:
"Bullish" (up trend) – The prices move upward
15
"Bearish" (down trend) – The prices move downward
(flat, whipsaw, sideways trend) – There is no certain price direction.
Three types of trends (tendencies) in duration:
Long - term – Trend for from 6 months up to several years.
Medium term (intermediate) - a trend for from 2 weeks up to 6 months.
Short-term (small) - a trend within 2 weeks.
Organic laws of the price movement: The valid trend with the greater probability will be
prolonged, than will change a direction. It will move in the same direction.
Basic Rule: “Trend Is your friend”
Consequence: " do not work against a trend ".
Basis of all methods and means of the technical analysis is revealing a trend - a prevailing
direction of the prices movement. There are three kinds of trends: "bullish", "bearish" and lateral.
“Bullish” –the growing trend is characterized by that each subsequent rise and a hollow on the
price chart, is higher than the previous one (Fig. 1). The line limiting such trend from below
refers to as a line of a trend.
Line of trend
“Bearish” – Or the descending trend arises when the subsequent peaks and hollows
lower than previous components (a Fig. 2). The line of a trend limits the price chart from above.
Line of trend
Line of support (resistance) – The line putting price minimum (maximum) together. In dynamics
of the market these lines frequently pass each other.
Line of support (resistance)
16
Lateral, or the horizontal trend is characterized by absence of the strongly pronounced
ascending or descending tendency of price movement in the market. At a lateral trend the price
changes in a horizontal range, in a vicinity of the average value.
Line of resistance
Line of support
Levels of support and resistance – Values of the prices that serve as original levels for the
price chart by virtue of the certain reasons. Coming nearer to those levels the probability of
rebound from values of the prices raises up. One of criteria of a trend power is his reaction to
levels of resistance and support. Breakthrough of a support / resistance level means, that the
dominating trend keeps the power. And if the trend encounters the resistance or support, being
not capable to overcome those, we receive especially strong signal about a weakness of a trend,
and there is more probability of a reverse in the future. Therefore the trading decisions in that
levels area should be made how the price chart will lead itself after it contacts this level.
The line of the channel can be constructed, if movements of a trend are uniform at first
approximation. The line of the channel is drawn in parallel a line of a trend and settles down
above the schedule of the price at the bull trend, and lower - at bear trend. In the figure resulted
below, 2 parallel lines designating an Up-trend, i.e. "bull" are shown. The red line lead from
below is a line of a trend and simultaneously is a line of support. The line from above is a line of
the channel and a line of resistance. Similarly the trend is under construction at a Down-trend
("bear") and Flat ` V (the lateral trend – there is no directed movement).
17
Following from above told information is necessary to work in a direction of movement at the
bull trend I.e. buy at the line of support also we close a position at the line of resistance, it is
similar at the bear trend. But there is already sell.
Lengths of correction
Exchange rates in FOREX change in zigzag way. Frequently the prices move against the
existing tendency. Such movement is called rolling back or correction. Fibonacci numbers and
factors have found a wide application in the technical analysis. Those numbers got certain
mystical sense so to speak. At the calculation of correction lengths (sizes of recoil of the price
against a trend) Fibonacci factors are used 0.382 and 0.618, and also factor 0.5.
There are three basic lengths of correction which apparently are equal accordingly 38,2 %,
50,0 %, 61,8 % from the gone length of a rate (between red horizontal lines) are visible in the
figure resulted below. Thus, it is visible, that the first correction (movement against the general
current tendency) there is up to 38,1 %, the second up to 50,0 % and the third accordingly up to
61,8 % from the gone length of a rate then there is a turn aside the basic movement.
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Correction - temporary change of a trend
Turn back - global change of a trend
Patterns of technical analysis
All set of typical patterns of the technical analysis can be divided into 2 parts:
continuation patterns and reversal patterns. Continuation patterns – the figures of corrective
(temporary) character
Reversal Patterns – The figures signalizing global reverse of the trend.
Let us see it detailed.
(Reversal Patterns)
First of all it is necessary to make sure that well defined previous trend is available before
you start to search for a reversal pattern. The first signal about correctness of the revealed pattern
is a breakthrough of any important line of a trend.
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1. Head And Shoulders – One of the most important and known S[qUXSXfcrh figures for
the bull trend. Its distinctive parts are a head and two shoulders. After you made sure that the
Head and Shoulders pattern has appeared, it is necessary to wait for the neck line breakthrough
that will define the end of all patterns and the beginning of a new descending trend. The minimal
quantity to of the price fall will be equal to distance between head and neck.
The neck line and two shoulders are shown in the picture.
Reversed Head and Sholders - Mirror image of just considered figure. All considered
rules also will be fair for this figure with necessary amendments on mirror reflection.
2. Double Top and Double Bottom are also frequently met figures. The parallel lines both
types of top and a bottom develop between are the levels of resistance and support.
Threefold Top or Threefold Bottom are weaker patterns (According to the point of view
of further back turn confidence)
Top is a signal about upcoming recession, and the bottom - about rise of the prices.
Basic (Continuation Patterns)
Triangles are the most widespread figures of such type. These triangles distinguished
depending on position of limiting lines. The top line is a line of resistance, and bottom - a line of
support. It is carried out for all fluctuations inside a triangle.
20
Most frequently it is possible to meet a narrowed triangle. Its frontlines converge into one
point and get symmetrically inclined to horizon. The narrowed triangle can correct any trend.
The ascending and descending triangles are met less often. One of the parts is parallel to an axis
of time, and another one is inclined, coming nearer to the first one with development of a triangle
(in time). The ascending triangle is more characteristic as bear market correction. The
explanation of this is such: its top front line is parallel to horizon and represents a strongly
pronounced level of resistance. At the same time its frontline below is dimmer and it is difficult
to define a level of support clearly.
After the end of each triangle it is necessary to expect renewal of movement in a direction
of a previous trend. It is possible to define the moment when the triangle is ended, by the
following criteria: there is an odd quantity (not less than five) of waves inside each triangle.
Narrowed, ascending and descending triangles usually come to the end close to the point of
crossing of the frontlines, but not later. After the end of a triangle the price should change its
value sharply (to raise or go down), i.e. to punch corresponding frontline. The phenomenon when
the price starts to change after the end of a triangle is called strike or impact. The minimal
purpose for strike is equal to the length of the biggest wave of a triangle. The strongest strike is
observed in case if the last wave of a triangle does not touch the frontline, and comes to the end
earlier. It is visible in the figure, that impact has taken place in 5/31 point area and has come to
the end with a change of quotation level up to 0.8460, just on size of the biggest wave of a
triangle - 80 pips.
21
Flags and Pennants are less often met figures. Their differences from triangles will
consist in a relative positioning of the top and bottom borders. The flag and pennant remind
descending and ascending triangles. Wedge is a model of the small triangle inclined against a
direction of the tendency. If the bias is in a direction of the tendency then the crisis of the
tendency is most probable. The breakthrough occurs between 2/3 up to 1 as a rule.
Analyzing "flag", "pennant” and “wedge " figures it is necessary to realize that potential
of the price movement after break trough is equal to a size of "staff", as a rule. The rectangle - is
very similar to threefold top. For definition of a kind of a formed pattern, the analysis of
oscillators and the analysis with the help of parameters of volume are used. After the
breakthrough the price will move in direction of it. The distance is not less, than height of a
rectangular. Borders of a rectangular will serve in the future as good levels of resistance -
support.
As the general recommendation to trading it is possible to notice that there is no point to
trade "inside" a triangle or any other pattern of continuation, because there are more chances to
lose money at such price fluctuations than chances to win. It is necessary to start the deal right
after the terminations of a continuation pattern when the sharp rise or recession of the prices is
expected.
Summarizing all above said about patterns of the technical analysis we shall notice, that
forecasting with only classical figures using is not too effective by virtue of criteria for definition
of this or that formation are indistinct. All signals are perceived subjectively: where one person
can see “Threefold Top ", another can see " Head and Shoulders ". However simplicity and
presentation peculiar to methods of the classical analysis can always help with a choice of the
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decision about the character of price change. For the quantitative description of dependences of
the prices on time there are the strict mathematical parities included in the second branch of
methods of the technical analysis exist - mathematical methods.
3.3 MATHEMATICAL METHODS
Statistical methods
Statistical methods separate trend price movements from non trend movements, extremes
of the market from its uniform development. Methods of this group in the various ways submit
signals about reverse of the bull or bear trend and also confirm this or that script of the price
development - growth, recession or absence of significant movements. For construction of the
indicators on the basis of statistical methods, the methods of mathematical statistics and
probability theory are used.
(Moving Averages)
Moving Aaverage It is one of the oldest, simple and consequently most frequently used
parameters. The following parameter is an arithmetical mean of closing prices of the fixed
number of previous periods of time, including current period.
Basic rules of building:
The longer the period of time the average is under construction lasts, the smaller order of
the most average should be chosen (For daily time charts the order is no more than 89, for
weekly charts - not more than 21), short averages can be applied without restrictions
The more longly average is, the less its sensitivity is. The average of very small order
gives many false signals. The average of very big order is constantly late. At a lateral trend the
averages are applied with bigger order, than as usual.
(Moving Average - MA):
MA = (The sum of the prices for the period of time) / Order of average
Main lack of st is that it reacts to one change of a rate twice: at reception of value and
at Its leaving out of rate.
(Weighted Moving Average - WMA):
WMA = (The sum of generation of prices and weights) / (sum of weights)
(Exponentially Moving Average - EMA):
EMA(t) = EMA(t - 1) + (K x [Price(t) - EMA(t - 1)],
aeV t - Current moment,
t - 1 - previous moment,
K = 2 / (n + 1),
n – Period of the average.
Main advantage of Qst is that it includes all prices of the previous period, not just a
piece apeared at the set of the period. Thus the greater weight is given to later values.
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The general rules of the analysis:
to find crossing points of the average and the chart of the price
to find the points following maximum or minimum of the average
to find the points of the largest divergence the average and the chart of price.
Look after direction of movement of the average.
Moving averages work good on trend market and very bad in non trend (flat) market
because delay of the moving averages will generate false signals.
( Bollinger bounds)
At the process building of the following indicator not only average, but also a standard
deviation of sequence of closing prices is calculated. Standard deviation is a measure of disorder
of random variables from average value that is equal to a square root from dispersion. Then three
lines are drawn: average and two bounds which will defend from it on quantity of a standard
deviation or the double value of a standard deviation.
According to bases of probability theory in a corridor in width of two standard deviations
gets about all 2/3 values of the prices, and there will be already 95 % of values in an interval in
four standard deviations. Crossing of Bollinger bounds or its breakthrough is usually a good
signal of the subsequent rebound.
(Parabolic Time Price System)
It is developed and described Wellas Wilder in 1976. The initial name ("stop and revers"
- SAR).
Primary goal of PTP is to show the basic trend and thus to define the moment of closing open
before positions during a reverse of a trend. The closing price is calculated daily under the
formula:
Stop(Tomorrow) = Stop(Today) + AF x [ EP(Today) - Stop(Today)], where
Stop(Today) - Current closing price;
Stop(Tomorrow) – Closing price of tomorrow;
EP(Today) - Extreme level of current day trading;
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AF - The factor of averaging, in the first day is accepted equal 0,02, then calculated under the
formula:
AF = 0,20 + n x 0,02, where n - Number of new tops (lowlands).
Classical signal for transaction fulfillment is crossing of the price chart with PTP line is a reverse
of a trend, or its time stabilization.
Oscillators Use of oscillator families is one of the most simple and at the same time
reliable ways of reception of forecasts about further movement of the price. As against moving
average the using of those oscillators is most useful for non trend market analysis. Oscillators
can be useful also at advanced trend the markets - to submission of a reverse signal. These are
more complicated indicators, than statistical, also represent a real attempt to find integrated
parameters allocateing essential movements from price fluctuations. The basic purpose of
oscillators - to reveal the moments of a trend reverse.
RSI - Relative Strength Index
The formula for calculation of values oscillator curve looks as follows:
RSI = 100 - (100/(1+RS)), RS = AU(n)/AD(n), aeV
AU(n) - Average value of the prices of closing appeared above previous prices for n days,
AD(n) - Average value of the prices of closing appeared below previous prices for n days.
The periods of time used for this oscillator can be different. As usual, if we will use a
smaller order, the curve will be more sensitive, we will get more signals. The basic signal, this
oscillator gives is the signal of extreme regions reaching (overbought and oversold). Range of
the oscillator change is from 0 up to 100. As the optimum value for sale is considered the value,
equal to 75, for purchase - 25. These zones are called:
1. Overbought - o/b
2. Oversold - o/s.
During the strong trend motions levels o/b and o/s respectively 80 and 20, while with the
lateral market - 70 and 30. It is possible to search for all patterns of technical analysis on RSI
charts as on the price charts. One additional important tool for prices forecasting via RSI index is
the divergence research of the motion of the index chart with the price chart.
There are two cases considered as divergence:
1. Index grows and the price falls or remains at the same level.
2. Index falls, and price grows or remains the constant.
Here are some variants of met divergence of the index and price charts in the picture.
Here are points noted where it is necessary to enter the market according to the signals points
supplied by the tool.
25
(Stochastics)
Stochastics in own formula consider not only prices of closing, but also maximum and
minimum prices for the specific period of time, i.e. include more information about the
movement of prices, than RSI. But in contrast to RSI, these indicators are more mobile, they may
change and have large amplitude. Such mobility makes some difficulties for the analysis of these
indicators.
K=(C-L)/(H-L)
Where :
K – the stochastic oscillator
w – the last close price
L – the lowest level for last n periods,
H – the highest level for last n periods. Offered number of using periods n 5 - 21.
Furthermore, it’s recommended twice to smooth x out by the simple moving average of of 3
periods length: %E (fast stockhastic) – this is the three period simple moving average from K,
and %D (slow stochastic) - this is the three period simple moving average from %x. In cases the
price reaches a new maximum, and on%K chart the new maximum is not shown up (negative
divergence), it should be expected that the trend will reverse downward. On the contrary, when
the price falls to the level of new minimum, but %K does not fall lower then its own minimal
price (positive divergence), the trend of price turn upward should be expected. The lift of %K
above %.D is the signal to the purchase with such divergences, and to sale – the fall of %K in
lower level than %.D.
26
(Momentum)
Momentum is one of basic often used oscillators. This indicator measures the of chahge of the
prices
Momentum = C - Cx,
where
w – the last close price,
Cx – close price of n days (hours, minutes) ago.
Momentum can take both the positive and negative values. The first attest to the fact that
the price of closing is located above the price of closing X days ago and therefore the prices
grow. Negative values speak, that the price of closing is lower than the price of closing X days
ago, and it means, prices diminish. The greater the positive or negative value of Momentum in
the absolute value, the more rapid the motion of prices is occurred. The Momentum chart is
fluctuated near the zero line. In this case the intersection says that the movement direction is
changed, i.e., market lost the momentum of inertia. Price still can grow, when the momentum is
already approached to zero. After the intersection of the zero line the movement higher than zero
indicates signal to buy and to sale if it is lower than zero.
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MACD - Moving Averages Convergence-Divergence
MACD - the most extended indicator, which is built on the difference of the averages. It was
comprised by Gerald Eppel as a difference between two exponentially smoothed averages
(EMA). These curves fluctuate around zero value. At the MACD analysis the standard methods
of the oscillator research are basically used. Intersection is a signal to purchase or sale. Indicator
reflects well the picture of divergence.
The intersection of zero level speaks about possible change of trend. If this level
intersects from the bottom to the top, then this is a signal to the purchase, if the intersection from
the top to bottom this is a signal to sale.
The intersection of the slow and more rapid lines also gives the signal. If the rapid line
intersects the slow one from the bottom to the top, then this is a signal to the purchase. If
therapid intersects slowly from the top to the bottom, then this is a signal to sale. This signal is
strengthened, if then confirmation of it is occured. Further parallel motion of lines to the zero
level and intersection of this level comes out as confirmation. The most important and strong
signals confirming the basic trend.
28
Recommendations regarding the use of oscillators of all types
1. Oscillators are best for using at the lateral trends. Otherwise the signals of those can prove to
be premature or even false.
2. the most checked signals are those, the state of overbought or oversold markets
is determined with.
3. The divergence between the price and oscillator always says about further strong reverse.
4. React only to the signals co directed with the main price trends.
3.4. FIBONACCI NUMBERS AND ELLIOT WAVE THEORY
Fibonacci Numbers
As Ralph Elliott admitted in his work “The Laws of Nature” the sequence of the numbers
discovered by Fibonacci in the XIII century became the mathematical basis of his theory. In
honor of Fibonacci the sequence discovered by him started to be called “Fibonacci Numbers”.
Fibonacci had published three great works, the most famous of those is called “Liber Abaci”.
Because of this book Europe learned the Indus- Arab system of the numbers, which extruded
Roman numbers traditional for that time. The works of Fibonacci had enormous value for the
subsequent development of mathematics, physics, astronomy and technology as a whole.
Numerical sequence is such: 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144... (And so on to
infinity). Fibonacci sequence has very curious special features - the almost constant interrelation
between the numbers is not the last one from those features. The sum of any two adjacent
numbers is equal to the following number in the sequence. Example: 3 + 5 = 8; 5 + 8 = 13 etc.
The ratio of any number of sequence to the following approaches 0,618 (after the first four
numbers). Example: 1: 1 = 1; 1: 2 = 0,5; 2: 3 = 0,67; 3: 5 = 0,6; 5: 8 = 0,625; 8: 13 = 0,615; 13:
21 = 0,619 etc. Note, as the value of relationships is fluctuating around value 0,618, moreover
the spread of fluctuations gradually becomes narrow; and also to the values: 1,00; 0,5; 0,67. The
ratio of any number to previous is approximately equal to 1,618 (reverse value 0,618). Example:
13: 8 = 1,625; 21: 13 = 1,615; 34: 21 = 1,619. The greater the quantity of those numbers is, the
closer they approach to the value 0,618 and 1,618. The ratio of any number to the following it
through one approaches to 0,382, and to that preceding through one - 2,618. Example: 13: 34 =
0,382; 34: 13 = 2,615. Fibonacci sequence contains and other curious correlations, or coefficient,
but those, above shown are very important and well known. As we already emphasized above,
indeed Fibonacci is not the original discoverer of his sequence. The fact is that coefficient of
1,618 or 0,618 was known to the even Ancient Greek and ancient-Egyptian mathematicians, and
it was called “ Golden coefficient” or “Golden Section”. We find its tracks in the music, art,
architecture and biology. Greeks used principle of “ Golden coefficient” or “Golden Section”at
the building of the Parthenon, Egyptians - great pyramid in Gize. Properties “ Golden
29
coefficient” they were well known to Pythagoras, Plato and Lednardo.Da.Vinchi. The
proportions of Fibonacci's numbers give the orientators not only of the possible levels of rebound,
but also indicate the possible value of motion in the case of continuing the tendency. If market
rebouns after motion, and then motion in the same direction continues, then in the typical case
the value of the continued motion can compose 1.618.
Arcs. Fan and high-speed lines.
One of the methods of application of the Fibonacci numbers is the construction of arcs.
Center for this arc is selected at the point of the important ceiling or bottom. A radius of arcs is
calculated with the aid of the multiplication of Fibonacci coefficients by the value of the
previous significant decrease or lift of prices. Selective coefficients in this case have
values of 0.333, 0.382, 0.4, 0.5, 0.6, 0.618, 0.666. In accordance with its arrangement of arc they
will play the role of resistance or support. Arcs are usually used with the fan or high-speed
lines to obtain idea not only about the levels, but also the time of the various price motions
appearance. The principle of their construction is relative to just described. We select the point
(or points) of past extrema and it is constructed vertical line from the apex of the second of them,
and horizontal - from the apex of the first one. Received thus vertical section is divided to the
parts corresponding to the Fibonacci coefficients. After this, we draw the rays emanating from
the first point and passing through those just chosen points. If we use relations into 1/3 and 2/3,
we will obtain high-speed lines, if stricter 0.382, 0.5, 0.618 - we obtain fan lines. Both those and
the others will serve as the lines of resistance or support for the price trend. The intersections of
fan lines and arcs will serve as signals for the development of the rotary points of trend,
moreover both on the price and and
time.
Elliot Wave Theory
Main discovery of Elliot consisted in the fact that the behavior of the"crowd" market
merchants or participants of the stock exchange game is subordinated to the characteristic laws.
In his opinion, social - mass psychological behavior is consecutive the stages of expansion,
enthusiasm and euphoria, which follow the damping, decline and depression. This diagram is
outlined in different periods of time, beginning from several minutes and concluding by centuries.
The so-called wave diagram serves as the basis of theory. Wave is a clearly distinguishable price
movement. Following the rules of psychological behavior, all motions of prices are divided into
five waves in direction of stronger trend, and to three waves - in the opposite direction.
5
30
B
3
4 A
1
2 C
(1) (3) (5) (t) (w) - the pulse waves
; (2) (4) (B) – correcting waves. As soon as the increase, which consists of 5 waves,
completes, 3 waves of the correction begin (t) (O) (w).
The tendency will be always developed on the basic 8- wave cycle independent on degree.
Waves can be divided (3 or 5). This laying out depends on the direction of larger wave, partly
which it is. Thus, waves (1)(3)(5) are divided into 5 waves each, since wave I - ascending.
Waves (2)(4) are divided into 3 waves of smaller degree, since these two waves go against the
tendency. Waves (A) (B) (C) compose the corrective wave of the II larger degree. (t) (w) - they
are divided into 5 waves, since they coincide with the direction of the elder tendency II. (O) - it
consists of three waves, as it goes against the tendency II.
General rule: Correction cannot consist of 5 waves.
If 5- wave drop is observed at a general growth trend, it is possible to establish with a
high portion of confidence that we deal concerning the I wave 3- wave (A) (B) of (C) of drop,
i.e., drop will be continued. At the “bear” market after 3- wave increase the tendency of drop
must be renewed, and the reanimation, which consists of 5 waves, warning that it, follows to
expect the more significant motion of prices upward. This wave can prove to be the I - st wave of
the “Bull” tendency.
The signs of waves, independently on their hierarchical degree
Wave 1
Almost half of all first waves is conceived in the base of market and serves as rebound from the
lowest levels. 1-st wave, as a rule, is the shortest of 5 waves, sometimes it is very dynamic, if this
is a base of the market.
Wave 2
As a rule, pass completely or almost completely the distance, passed by the1-st wave, but it is
retained above the level of the 1-st wave base .
Wave 3
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As a rule, the longest and most dynamic of all 5 pulse waves. The intersection with the wave of 3
level of apex 1 of wave register all types of classical breakthroughs and the signal to the opening
of long positions. A sharp increase in the volumes of the trade is fallen to this wave. Wave 3 can
not ever be short.
Wave4
This wave has a complicated structure, it just like a wave 2 is the phase of correction or
consolidation;
however, it is characterized by its structure (rule of alternation) - triangles frequently appeaed
General rule: The base of wave 4 never intersects the apex of wave
Wave5
It is less dynamic than wave 3. When this wave comes to the market, many indicators (oscillators)
lag behind the motion of prices, and appear negative divergences (divergence), preventing about
the approximation of the market top.
Wave A
Partition into 5 smaller waves is the most convincing signal of the appearance of this wave, in
this case an increase in the volume corresponds to reduction in the price.
Wave B
This wave reflects rebound of prices upward with the new descending tendency. Low volume is
the characteristic for it. In case this double top is formed.
Sometimes even overlaps the apex of wave 5.
Wave C
Frequently it descends considerably lower than base of wave A, in particular, with drawing of
the line of trend under the base of wave 4 and wave A on the chart appears the figure of “head
and shoulders”. 5
B
3
A
4
1
2 C
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Conclusion
The complete cycle of the “Bull” market consists of 8 waves: 5 waves of increase, then 3
waves of drop follow. Tendency is subdivided into 5 waves in the direction of the following in
the hierarchy, the more prolonged tendency. The correction always consists of three waves.
Simple corrections are of two types: zigzags 5-3-5 and plane waves 3-3-5.
As a rule triangles are formed on the fourth waves (this model always precedes the last
wave). Triangle can also be the corrective wave B.
Any wave is the part of the longer wave and it is subdivided into the shorter waves.
zcXae[ Xec[ Tq TiR]WgZcrh UXWc S[ZfdaTU[VfZd. Remaining two must remain equal in time
and extent. Fibonacci sequence is the mathematical basis of the Elliott wave theory. A quantity
of waves, forming tendency, coincides with Fibonacci numbers. The Fibonacci coefficients and
the relations of the length of correction based on those are used for determining the price
orientators. The ratio of the length of correction to the previous motion of market frequently is
equal to 62%, 50% and 38%. The rule of alternation warns that there is no need to await the
identical manifestation of price dynamics twice at once. The “bull” markets must not descend
lower than base of the previous fourth wave. Wave 4 must not gush over wave 1.
The basic aspects of the Eliot wave theory (by way of significance) are waveform, the
correlation of waves and time. The procedure of prognostic calculations is constructed on the
numerical correlation of values “movement-rebound” must give the coefficients “Golden
Section” i.e.,:1,618; 2,618; 4,236 (at the movement )
- 0,618;' 0,382; 0,236 (at the rebound);
These numerical values are those important levels, the market “Remindes” in the price change
process. trader is oriented specifically on those levels in his work. The simplest use of Fibonacci
numbers find at the level of recoil or rebound calculation. As prices cannot continuously grow or
fall prolonged time, after each of those changes there is one or another value or another recoil to
the other side. This phenomenon is evident after strong and prolonged motion especially vividly.
In this case the rebound 33% is most probable, and the rebound 66% is least probable. The use of
Fibonacci's sequence makes it possible to increase the most probable lower boundary from 33%
to 38,2% (number of Fibonacci 0,382) and at the same time decrease the least probable distant
boundary from 66% to 61,8% (Fibonacci number 0,618). The achievement of the level in 38,2%
occurs extremely often, which is caused by the enormous popularity of Elliott Wave Theory.
Actually, as the majority of participants in the market expects this rebound precisely, it occurs.
33
The calculation of recoil and rebound levels is a sufficiently simple occupation that makes this
analysis very attractive. Besides, the recoils and rebounds function both on the main trends and
on the secondary and the short term trends. Thus, it is possible to observe them both on the
weekly and on the hourly charts.
34
Chapter 4. STOCKJOBBING PSYCHOLOGY
Trading results analysis
Analysis and prognostication of the market, the composition of trading plan and practical
trade are considered as the necessary and only actions at work in the financial market. It is out of
focuse in casethat the analysis of own actions in the market is not less important part of work.
Without the analysis of own successes and failures, without making of the statistics of profits and
losses it is impossible to increase the result of trade. Financial markets and analysing methods of
the market are that contradictory and ambiguous so work in the financial market is a continuous
scientific research. Necessary:
1. to keep records, not only recording economic indices and events, but also the reaction of the
market at them.
2. to conduct the registration of making and falsity of all of technical and computer analysis
signals;
3. to conduct the registration of the incomprehensible motions of the market prices;
4. to write down own emotions and moods that substantially influenced decision making;
Without the registrations of all events at the market and your reactions on them you will not be
able to analyze the reason for successes and failures.
Furthermore, usually after the short temporary period it is possible to analyze situation on the
market more accurately and to give the more precise explanation to those events, which were
obscure in their time. For example, you can learn about intervention of one of the central banks
only next day. The discovery new signals can become the result of the analysis of your records
for the prolonged time interval. Even if you do not invent new methods, the registration of events
will allow you to feel the market more thinly. It is necessary to constantly return to the records.
The repeated analysis of past events on the basis of your new experience makes possible for you
to be improved by more rapid rates. This scrupulous attitude to the market exploration is
especially important in the initial stage, when you only study your work at the market.
The association of all data and different kinds of the analysis specific
Search the charts of three temporary periods
1. Good lines of trends - basic, average and short term trends. Moreover we draw such lines of
trends not only through the maximum and minimum prices of entire chart, but we also search for
the lines “inside” the chart, which are alternately for its different parts first the line of support,
then the line of resistance.
2. The significant levels, where many maximal, minimal prices or closing prices were
encountered.
35
1. we determine the force of each line or level.
2. in the absence of channel, build theoretical lines in parallel to existing lines.
3. we calculate the levels of recoils or rebounds from 38%, 50%, 62% levels.
4. we attempt to find the continuation or reversal patterns.
5. If such figures are visible distinctly, then we are prepared for the possible course of
events and we calculate purpose.
6. we attempt to analyze charts in the point of view of the Elliott wave theory.
7. we carry out the high-speed and fan lines
8. we determine possible cycles and consider the right or left displacement.
9. we analyze the candlestick charts.
1. at the computer analysis we analyze the only charts of the indicators, which we
mastered sufficiently well, paying attention to:
2. divergence;
3. Trends of these indicators;
4. Critical “overbought” and “oversold” areas;
5. intersection of the rapid and slow lines;
6. Intersection of the “zero” level.
With the fundamental analysis we attempt to reveal a main trend in development of the
economy in order to determine the current tendency of strengthening or weakening currency. For
our purposes with this analysis is important to determine current state of the economy of the
individual country, as correlation between directions and rates of the development of the
economies of the different countries. I.e., it is necessary to analyze not only the economic state of
the individual countries, but also to achieve their comparative analysis. Currency rate is the
relation between two currencies; therefore the greatest effect on it has precisely the difference
between the levels of the development of the economies of these countries. It is necessary to
analyze the cross - courses of currencies in order to have the capability to determine the relative
speed of weakening or strengthening currencies, and also not to miss the rare case of their
differently directed motion. It is necessary to analyze political events, statements and initiatives
of the first persons of state. For this it is necessary to actively use the media: television, radio,
newspapers and periodicals. To make entire enumerated work according to the analysis of the
market during one day, week or even month is impossible. But, firstly, who said that this is an
easy work? In secondly, what work does not require enormous efforts at the initial stage? Thirdly,
there is no necessity to make daily its enormous part. For example, it suffices to carry out once a
week or once two-three weeks for the analysis of weekly charts. You do not have to draw new
lines on those charts, because the new significant lines appear not too often. Furthermore, you
will remember well the majority of information such as significant levels, basic trends, the state
of computer indicators and etc. therefore the analysis of new data will become practically
instantaneous in a couple of years.
36
Capital management and trading tactics
The safest trade - in the direction of intermediate-term trend.
Buy on short term drops in the prices at the ascending tendency and sell on the short term with
descending reanimations.
Preserve profitable positions as longer as possible, and close the unprofitable in time.
Use protecting stop - orders for limiting of the possible losses.
Do not yield to emotions.
Compile the plan of your work in the market and follow it.
Diversify your briefcase, but do not forget about “Golden Mean”.
Adding positions (erecting pyramid), adhere to the following rules:
H) a number of positions at each subsequent level must be less than on previous;
B) add only to the profitable positions;
C) JKLMNOP JQ OMRPSTUVWQ L XRYWMZJY[ \M]K^KU[;
D) place a stop- order as close as possible to the break-even sales level (break-even
point).
First of all close unprofitable positions, then profitable.
Analyzing situation, move from the long-term chart to the the short termchart.
Train your self not to fear to remain in the minority. There is nothing terrible in this;
when your estimation is accurate, the majority of the other participants of the market, will not
agree with it, as a rule. It is necessary to constantly learn, to improve your knowledge and habits
of all analysis forms.

The E-Book of Technical Market Indicators [Wall Street Courier]

2007-08-25T18:42:00.000-07:00

The transparency of the American markets offers an array of indicators and allows deep insights of prevailing sentiment. You find the activities of NYSE members like specialists and floor traders, public and odd lot short sales, the Short Interest Ratio as well as the large block transactions of the institutional investors published every week. Other tools for technical analysis include trend indicators, daily advances and declines, daily new highs and lows, volume, indices, put/call ratios and other useful information like Stochastics, RSI, MACD, TICK and more. The problem is only that all these indicators contradict each other most of the time. Countless books have been written on this subject, and no matter how many will be written in the future: always be aware that there is no such thing as the Holy Grail of the stock market. But some people are more successful than others and the answer is quite simple:
No indicator is right all the time and you don't have to be right all the time. Just be right a higher percentage of the time than wrong. Choose some reliable indicators and stick to them. Don't follow some indicators for a while and switch to some others if they fail. Don't be a technician in the first half of the year and a fundamentalist the next half. Be consistent and disciplined in your approach. Don't abandon a good indicator because you think this time everything is different.
It takes of course a lot of guts because the opinions of the most widely quoted gurus of Wall Street are usually contrary to your indicators at that time. This is much easier if you don't use margin. You will sleep a lot better if you buy fifty shares of IBM with the money you can spare than two hundred shares on credit.
Happy Trading
Wall Street Courier
www.wallstreetcourier.com Page 2
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Table of Content
Advance-Decline Indicators...................................................................................................5
Advance-Decline Line........................................................................................................5
Advance-Decline Ratio.......................................................................................................7
Upside-Downside Volume Ratio........................................................................................8
Upside-Downside Volume Line..........................................................................................9
Upside-Downside Volume Net Difference........................................................................11
Advance-Decline Net Difference......................................................................................12
Global Futures Advance-Decline Index............................................................................13
Global Futures Upside-Downside Volume Index..............................................................13
Market Indicators.................................................................................................................14
High-Low Differential Index..............................................................................................14
High-Low Ratio................................................................................................................15
Global Futures High-Low Index........................................................................................16
Global Futures Bottom Indicator......................................................................................16
Cycles.............................................................................................................................19
Large Block Index............................................................................................................19
Short Term Trading Index (ARMS Index or TRIN)...........................................................20
Trend Indicator.................................................................................................................22
CBOE Volatility Index (VIX)..............................................................................................23
Index Options Put/Call Ratio............................................................................................23
Call/Put Ratio...................................................................................................................24
Global Futures Put/Volume Ratio.....................................................................................25
Smart Money Flow Index.................................................................................................26
Global Futures Timing Indicator.......................................................................................27
Global Futures Market Timer Index..................................................................................28
Global Futures Fear Indicator..........................................................................................29
Wall Street Courier Index.................................................................................................29
Global Futures Trading Index...........................................................................................30
Global Futures Speculation Index....................................................................................31
Program Trading..............................................................................................................32
Calendar Spread..............................................................................................................33
Odd-Lot Differential Index................................................................................................34 Page 3
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Short Sales Statistics...........................................................................................................35
The NYSE Short Interest Ratio........................................................................................35
Odd-Lot Short Sales Ratio...............................................................................................36
Floor Traders Short Sales Ratio.......................................................................................36
Specialist Short Sales Ratio.............................................................................................37
NYSE Member Short Sales Ratio....................................................................................38
Public Short Sales Ratio..................................................................................................38
Odd-Lot Balance Index....................................................................................................39
Odd-Lot/Floor Trader Short Sales Ratio...........................................................................40
Global Futures Odd-Lot/Specialist Short Sales Ratio.......................................................40
Global Futures Public/Member Short Sales Ratio............................................................41
Public/Specialists Short Sales Ratio................................................................................42
High readings indicate heavy shorting by the public (the so called crowd) and therefore bottoms, low readings indicate tops.................................................................................42
Global Futures NYSE Member Trading Indicator.............................................................43
Sentiment Indicators............................................................................................................44
Investor Sentiment...........................................................................................................44
Commitments of Traders Report......................................................................................46
Appendix.............................................................................................................................48
Dow Jones Industrial........................................................................................................48
S&P 500...........................................................................................................................48
Risk Statement....................................................................................................................49
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Advance-Decline Indicators
Advance-Decline Line
The Advance-Decline Line is a market breadth indicator and should be compared to the other market indices like the Dow Jones or S&P 500. Daily or weekly NYSE data is used in the calculation. Because the Advance-Decline Line reflects the action of the general market, any divergences are watched closely by market technicians. As long as the Dow and the Advance-Decline Line are moving in the same direction the trend will continue. If the Dow makes a new high which is not confirmed by a high of the Advance-Decline Line, caution is warranted. Vice versa, if the Dow makes a new low and the Advance-Decline Line doesn't you should cover your short sales.
ADVANCE - DECLINE LINE WEEKLY10000012000014000016000096-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18© WallStreetCourier.com
To calculate your own weekly Advance-Decline Line is very simple and you can begin your calculations at any time. Just pick a large enough base number like 100000. Then you calculate each week (or day) the difference between advances and declines by adding the advances and subtracting the declines. If you have 1269 advances and 1457 declines on your first week, the reading of your newly created weekly Advance-Decline Line would be 99812 (example below).
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The Advance-Decline Line gave a useful example in 1999. During the strong bull market the advance was quite broad and the A/D Line moved in tandem with the Dow. But when the Dow made new highs in the beginning of 1999 the A/D Line was already lagging behind, indicating a weakening of the general market. Internet mania and technology craze kept the market going for a while.
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Advance-Decline Ratio
The Advance-Decline Ratio is also market breadth indicator. It is calculated by dividing the number of advancing issues by the number of declining issues using daily or weekly NYSE data. It works very well as an overbought/oversold indicator and as a momentum indicator. A moving average should be used to smooth out the swings.

This chart shows you the weekly NYSE Advance-Decline Ratio on a 10-week moving average. Readings below 90 indicate intermediate bottoms and readings above 170 tops.
ADVANCE-DECLINE RATIO0,400,801,201,602,002,4095-08-1195-10-0695-12-0196-01-2696-03-2296-05-1796-07-1296-09-0696-11-0196-12-2797-02-2197-04-1897-06-1397-08-0897-10-0397-11-2898-01-2398-03-2098-05-1598-07-1098-09-0498-10-3098-12-2599-02-1999-04-1699-06-1199-08-0699-10-0199-11-2600-01-2100-03-1700-05-1200-07-0700-09-0100-10-2700-12-2201-02-1601-04-1301-06-08© WallStreetCourier.com10-DAY MOVING AVERAGE Page 7
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Upside-Downside Volume Ratio
The Upside-Downside Volume Ratio is also market breadth indicator. It is calculated by dividing the volume of advancing issues by the volume of declining issues, using daily or weekly NYSE data. It works very well as an overbought/oversold indicator and as well as a momentum indicator. A moving average should be used to smooth out the swings.

UPSIDE/DOWNSIDE VOLUME RATIO8010012014016018096-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18© WallStreetCourier.com
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Upside-Downside Volume Line
The Upside-Downside Volume Line is a market breadth indicator and should be compared to the other market indices like the Dow Jones or S&P 500. Daily or weekly NYSE data is used in the calculation. Because the Upside-Downside Volume Line reflects the action of the general market, any divergences are watched closely by market technicians. As long as the Dow and the Upside-Downside Volume Line are moving in the same direction the trend will continue. If the Dow makes a new high which is not confirmed by a high of the Upside-Downside Volume Line, caution is warranted. It is more affirmative than the Advance-Decline Line and it gave a perfect sell signal in January 2000, when the Dow made a new high and the Upside-Downside Volume Line lagged behind (charts below). Vice versa, if the Dow makes a new low and the Upside-Downside Volume Line doesn't, you should cover your short sales. To calculate your own weekly Upside-Downside Volume Line is very simple and you can begin your calculations at any time. Just pick a large enough base number like 1000000. Then you calculate each week (or day) the difference between the upside volume and downside volume by adding the volume of advancing issues and subtracting the volume of declining issues. If you have an upside volume of 673210 and a downside volume of 732827 on your first week, the reading of your newly created weekly Upside-Downside Volume Line would be 940383 (example below).

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Here is a beautiful example of the Upside-Downside Volume Line. Volume moves the markets and this indicator gave a perfect sell signal in December 1999, when the Dow made a new high and the Upside-Downside Volume Line didn't. It would have kept you also on the right side of the market right to the top.
ADVANCE - DECLINE VOLUME LINE10000003000000500000070000009000000110000001300000015000000170000001900000021000000230000002500000096-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18© WallStreetCourier.comDIVERGENCE
DOW JONES WEEKLY CLOSE5000600070008000900010000110001200096-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18© WallStreetCourier.com DIVERGENCE
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Upside-Downside Volume Net Difference
Another method used by market technicians is to calculate the net difference between the upside- and downside volume. Daily or weekly data can be used. The net difference between upside- and downside volume is calculated weekly and the result is added. To smooth out the swings, a 10-week moving average should be applied. Below there is an example for weekly calculations:

UP - DOWNVOLUME NET DIFFERENCE-1000000-5000000500000100000096-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18© WallStreetCourier.com
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Advance-Decline Net Difference
Another method used by market technicians is to calculate the net difference between advances and declines. Daily or weekly data can be used. The net difference between advances and declines is calculated weekly and the result is added. To smooth out the swings, a 10-week moving average is applied. Below there is an example for weekly calculations:

The chart went from extremely overbought in July 1997 to heavily oversold in September 1998: ADVANCE - DECLINE NET DIFFERENCE-1500-1000-500050010001500200096-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18© Page 12
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Global Futures Advance-Decline Index
This indicator is calculated by dividing the weekly number of advances and declines by the number of total issues traded. A 10-week moving average is applied to smooth out the swings.
ADVANCE - DECLINE INDEX WEEKLY0,300,350,400,450,500,550,6096-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18© WallStreetCourier.comADVANCESDECLINES
Global Futures Upside-Downside Volume Index
This indicator is calculated by dividing the weekly upside and downside volumes by the weekly total volume. A 10-week moving average is applied to smooth out the swings. UPSIDE - DOWNSIDE VOLUME INDEX WEEKLY0,360,380,400,420,440,460,480,500,520,540,5696-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18© WallStreetCourier.comUPSIDE VOLUMEDOWNSIDE VOLUMEy Page 13
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Market Indicators
High-Low Differential Index
Like the advance-decline line, the high-low indicators produce signals when they diverge from the action of the indices like the Dow Jones or the S&P 500. It is considered unhealthy for the market climate if the indices make new highs without many stocks reaching new highs at the same time. Chart technicians use various methods to spot divergences from the major market indices.
The High-Low Differential Index produces good longer term signals when it diverges from the action of the Dow over a prolonged period of time. Daily or weekly data may be used and the calculation of this indicator is very simple; just subtract the daily or weekly new lows from the new highs to get the differential and apply a moving average to smooth out the swings. If you have 479 new highs and 31 new lows on your first week, the reading of your newly created weekly High-Low Differential Index would be 448 (example below).

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HIGH-LOW DIFFERENTIAL INDEX-1500-1000-50005001000150096-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18© WallStreetCourier.com
High-Low Ratio
The High-Low Ratio is the number of new highs divided by the numbers of new lows. Daily or weekly data may be used in the calculation. Readings do get sometimes very distorted if there are for instance about 600 new highs and 5 new lows or vice versa. A long-period moving average should therefore be applied.
HIGH-LOW RATIO WEEKLY0246810121416182096-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18© WallStreetCourier.com
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Global Futures High-Low Index
This indicator is calculated by dividing the weekly number of highs and lows by the number of total issues traded. A 10-week moving average is applied to smooth out the swings. Like the advance-decline line, this indicator produces signals when it diverges from the action of the indices like the Dow Jones or the S&P 500. It is considered unhealthy for the market climate if the indices make new highs without many stocks reaching new highs at the same time.
HIGH -LOW INDEX0,010,030,050,070,090,110,130,150,170,190,210,230,2596-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18© WallStreetCourier.comLOWSHIGHS10- WEEK MOVING AVERAGE
Global Futures Bottom Indicator
The Global Futures Bottom Indicator was developed by R. Koch of Wall Street Courier. To our knowledge there is no previous mentioning of this indicator in any financial publication. It does not appear very often but it is extremely reliable when the market is at a turning point. It prevents long-term investors from buying at the wrong time and works especially well for option traders because of its incredibly perfect timing. Unfortunately this indicator does not tell you when to sell. Set yourself a limit if you trade options, or use trailing stop-loss orders if you are a long-term investor.
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Check BARRON`S every Monday for the weekly:
• CALLS ADVANCES
• CALLS DECLINES
• PUTS ADVANCES
• PUTS DECLINES
• (CBOE MARKET REPORT)
It takes you only five minutes every week to calculate the Global Futures Bottom Indicator:
• Divide the number of calls advancing by the number of calls declining
• Divide the number of puts declining by the number of puts advancing
• Subtract the result of calls adv./decl. from the result of puts decl./adv.
• Plot the difference on a chart and ignore the decimal.

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THE GLOBAL FUTURES BOTTOM INDICATOR-25257512517522527532537542547596-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18© WallStreetCourier.com THE GLOBAL FUTURES BOTTOM INDICATOR-20,00-10,000,0010,0020,0030,0040,0050,0096-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18© WallStreetCourier.comBUYBOTTOM
Any zero or minus reading indicates a bottom. Since this indicator was invented and developed it only failed twice on a minus reading if compared to the Dow Jones. This was due to panic selling on August 3rd and August 24th 1990 when Saddam invaded Kuwait.
• Readings between 1 and 5 are also very reliable and indicate intermediate bottoms in bull markets.
• Readings up to 25 may work but should be counterchecked with other indicators such as the Global Futures Market Timing Indicator.
• Readings above 600 are good breadth indicators and show you that a powerful market move on the upside is to be expected.
• Ignore all other readings.
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For your convenience there is a track record attached (377 kb) back to 1985 for you to check the value of this indicator. Plot the numbers on a chart and compare it with previous market action. Feel free to make use of our indicator if you find it useful. Feel also free to publish it as long as you mention the source and call it the Global Futures Bottom Indicator. Download the track record at http://www.wallstreetcourier.com/technician/timing-indicators/track-record.htm
Cycles
Cycle analysis has a long history and is also part of technical analysis. All markets appear to be subject to cyclical patterns and forces caused by economic influences and countless other factors. Stock market movements seem to take place with cyclical regularity and timing your trades to coincide with anticipated cyclical movements can be very rewarding. Wall Street Courier offers some very reliable cycles for subscribers.
Large Block Index
The Large Block Index is calculated from the number of upticks and downticks in large block transactions of single trades of 10 000 shares and over. An uptick is at a price higher than the last previous trade and initiated by a buyer. A downtick is at a price lower than the previous trade and initiated by a seller. The rationale behind the Large Block Index is quite simple. It measures activities and extremes in institutional sentiment and behavior. When the ratio of upticks rises to very high levels, it indicates that the institutions are buying heavily, reaching a fully invested position and therefore lowering their cash reserves.
Conversely, when the ratio of downticks rises to high levels, it indicates that the institutions are selling and are raising cash. When the institutional behaviour reaches extremes, the market will turn in a contrary direction. This indicator has often signaled major reversals and has also prevented investors from plunging into the market at the wrong time. The chart below shows you this indicator on a 10-day moving average.
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THE GLOBAL FUTURES LARGE BLOCK INDEX0,800,850,900,951,001,051,101,151,201,251,301,351,401,451,5098-08-1498-09-1198-10-0998-11-0698-12-0499-01-0199-01-2999-02-2699-03-2699-04-2399-05-2199-06-1899-07-1699-08-1399-09-1099-10-0899-11-0599-12-0399-12-3100-01-2800-02-2500-03-2400-04-2100-05-1900-06-1600-07-1400-08-1100-09-0800-10-0600-11-0300-12-0100-12-2901-01-2601-02-2301-03-2301-04-2001-05-1801-06-15© WallStreetCourier.comBUYSELL10-DAY MOVING AVERAGE
Short Term Trading Index (ARMS Index or TRIN)
The Short Term Trading Index was invented over 30 years ago by Richard Arms and is also known as ARMS Index. It is calculated by dividing advancing issues by declining issues and advancing volume by declining volume. The first result is then divided by the latter and the result is the TRIN. If the index is above one, the average volume of stocks that fell on the NYSE was greater than the average volume of stocks that rose and vice versa. But it is most confirmative when it reaches extremes. This indicator rises sharply when the market is most depressed and selling is climaxing, and falls to very low levels during buying frenzies.

SHORT TERM TRADING INDEX WEEKLY (TRIN)0,700,901,101,3096-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18© WallStreetCourier.comBUYSELL4-WEEK MOVING AVERAGE
TRIN DAILY0,700,951,201,451,7096-01-0296-02-2796-04-2396-06-1896-08-1396-10-0896-12-0397-01-2897-03-2597-05-2097-07-1597-09-0997-11-0497-12-3098-02-2498-04-2198-06-1698-08-1198-10-0698-12-0199-01-2699-03-2399-05-1899-07-1399-09-0799-11-0299-12-2800-02-2200-04-1800-06-1300-08-0800-10-0300-11-2801-01-2301-03-2001-05-15© WallStreetCourier.com10-DAY MOVING AVERAGEBUYSELL
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Trend Indicator
Why are some traders more successful than others? There are probably as many answers as there are traders out there. But you will undoubtedly agree that most of the money is being made in a trend, especially as far as options and futures are concerned. In options trading your biggest enemy by far is time. You need to have the patience and discipline to wait for a trend in the market in order to succeed on the long run. The same rule applies to any short-term oriented trader. The Global Futures Trend Index shows you clearly when to enter the market. This index is computed by dividing the daily highs by the sum of the daily highs and lows. A 10-week moving average is applied to smooth out the swings. As long as the readings of this index stay above the 80%-level there is a solid bullish trend in progress. Any weakness should be used to go long or to buy call options, preferably of stocks which are in a clear uptrend, or stock index options. Readings below 20 indicate a bearish trend. Strong days should be used to short stocks which are already weak, or to buy put options. As long as this indicator is in neutral territory don't do anything unless you are a savvy stockpicker, insider or a long-term value investor.
THE GLOBAL FUTURES TREND INDEX0,000,100,200,300,400,500,600,700,800,901,0096-01-0296-02-2796-04-2396-06-1896-08-1396-10-0896-12-0397-01-2897-03-2597-05-2097-07-1597-09-0997-11-0497-12-3098-02-2498-04-2198-06-1698-08-1198-10-0698-12-0199-01-2699-03-2399-05-1899-07-1399-09-0799-11-0299-12-2800-02-2200-04-1800-06-1300-08-0800-10-0300-11-2801-01-2301-03-2001-05-15© WallStreetCourier.comBULLISH TRENDTRADING RANGE MARKETBEARISH TREND
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CBOE Volatility Index (VIX)
VIX computes volatility of four OEX contracts in two nearby months and is published daily by the CBOE. Options selected for this index are one call and one put just out of the money, and one call and one put just in the money, for each of the two front months of the OEX (S&P 100). Extremely high readings of VIX indicate bottoms and low readings tops.
VOLATILITY INDEX (VIX) WEEKLY0102030405096-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18©
Index Options Put/Call Ratio
This indicator is calculated by dividing the weekly volume of S&P 100 call options by the weekly volume of S&P 100 put options. Big call volume appears at market tops and big put volume at bottoms. But call/put ratios of the indices like OEX and SPX are distorted and clouded by arbitrage and hedging and do therefore not always reflect true investor sentiment.
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CALL/PUT RATIO OEX0,350,550,750,951,1596-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18© WallStreetCourier.com4-WEEK MOVING AVERAGEBUYSELL
Call/Put Ratio
This indicator is calculated by dividing the daily or weekly volume of call options by the daily or weekly volume of put options. Big call volume appears at market tops and big put volume at bottoms. Only CBOE equity options or all CBOE options should be used for this indicator. Call/put ratios of the indices like OEX and SPX are distorted and clouded by arbitrage and hedging and do therefore not always reflect true investor sentiment. The chart below shows you the weekly call/put ratio on a 4-week moving average to smooth out the swings.
CALL/PUT RATIO ALL CBOE OPTIONS1,001,251,501,752,002,252,5096-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18© WallStreetCourier.comSELLBUY4-WEEK MOVING AVERAGE Page 24
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CALL/PUT RATIO EQUITY OPTIONS1,502,002,503,0096-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18© WallStreetCourier.comBUYSELL4-WEEK MOVING AVERAGE
Global Futures Put/Volume Ratio
The Global Futures Put/Volume Ratio is a market sentiment indicator. It is calculated by dividing the volume of CBOE equity put options by the NYSE volume on a weekly basis and is interpreted in a contrary fashion. High readings signify extreme pessimism and fear, sometimes outright panic and indicate very often bottoms. Low readings of this indicator result from the anticipation of higher prices ahead and are therefore considered bearish. It is in our opinion more affirmative than the widely used put/call ratio which has gained widespread notice. THE GLOBAL FUTURES PUT/VOLUME RATIO1520253035404596-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18© WallStreetCourier.com Page 25
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Smart Money Flow Index
The Smart Money Flow Index has long been one of the best kept secrets of Wall Street. Everybody knows the importance of a closing price and other last hour indicators like the Closing Tick, which we publish daily for free on our portal. The Smart Money Flow Index is therefore calculated by taking the action of the Dow in two time periods: the first 30 minutes and the close. The first 30 minutes represent emotional buying, driven by greed and fear of the crowd based on good and bad news. There is also a lot of buying on market orders and short covering at the opening. Smart money waits until the end and they very often test the market before by shorting heavily just to see how the market reacts. Then they move in the big way. These heavy hitters also have the best possible information available to them and they do have the edge on all the other market participants. The Smart Money Indicator is calculated like the Advance-Decline Line. You can easily do it yourself if you don't want to pay our subscription rate of $1.50 weekly (based on a 6-month membership). Just start at any given day, subtract the price of the Dow at 10 AM from the previous day's close and add today's closing price. The result is plotted on a chart, together with the closing price of the Dow only. Whenever the Dow makes a high which is not confirmed by the SMI there is trouble ahead (chart below). Watch the divergence around June 1998, February 2000 and September 2000. Watching this indicator is like being on a plane and see the pilots jumping off with parachutes. This indicator is suitable only for investors with a longer time horizon. Such investors should buy blue chips when the indicator gives a buy signal, and sell and sell short on a divergence.
SMART MONEY FLOW INDEX60008000100001200098-01-0298-01-3098-02-2798-03-2798-04-2498-05-2298-06-1998-07-1798-08-1498-09-1198-10-0998-11-0698-12-0499-01-0199-01-2999-02-2699-03-2699-04-2399-05-2199-06-1899-07-1699-08-1399-09-1099-10-0899-11-0599-12-0399-12-3100-01-2800-02-2500-03-2400-04-2100-05-1900-06-1600-07-1400-08-1100-09-0800-10-0600-11-0300-12-0100-12-2901-01-2601-02-2301-03-2301-04-2001-05-1801-06-15© WallStreetCourier.comDOW JONES CLOSESMART MONEY FLOW INDEXBearishDivergenceBearishDivergence
BullishDivergence
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Global Futures Timing Indicator
This indicator, like the Global Futures Bottom Indicator, is unknown until now to the investment community and is not available anywhere else. To our knowledge there is no previous mentioning of this indicator in any financial publication. It was also developed by R. Koch of Wall Street Courier. The Global Futures Timing Indicator gives buy signals more often and is an excellent supplement to the Global Futures Bottom Indicator, especially when this one has readings between 6 and 25. It prevents investors from buying at the wrong time and it works also very well for option speculators and position traders because of its expert timing.
Both indicators together should improve your trading substantially and will build you an estate in the years ahead. Just start buying good value stocks whenever the readings of the Global Futures Timing Indicator shrink to single digit numbers. This takes of course a lot of guts because the opinions of the widely quoted gurus are usually contrary at this time. Minus readings indicate an intermediate bottom.
THE GLOBAL FUTURES TIMING INDICATOR-20,00-10,000,0010,0020,0030,0040,0050,0060,0070,0080,0096-01-1296-02-2396-04-0596-05-1796-06-2896-08-0996-09-2096-11-0196-12-1397-01-2497-03-0797-04-1897-05-3097-07-1197-08-2297-10-0397-11-1497-12-2698-02-0698-03-2098-05-0198-06-1298-07-2498-09-0498-10-1698-11-2799-01-0899-02-1999-04-0299-05-1499-06-2599-08-0699-09-1799-10-2999-12-1000-01-2100-03-0300-04-1400-05-2600-07-0700-08-1800-09-2900-11-1000-12-2201-02-0201-03-1601-04-2701-06-08© WallStreetCourier.comSTART BUYINGINTERMEDIATE BOTTOM
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Global Futures Market Timer Index
The Global Futures Market Timer Index is a proprietary indicator of Global Futures and not available anywhere else. It was unknown until now to the investment community and to our knowledge there is no previous mentioning of this indicator in any financial publication. The Global Futures Market Timer Index gives buy signals when it has readings below 1,00 and sell signals above 1,20. Start buying good value stocks whenever the readings of this index fall below 1,00. This takes of course a lot of guts because the opinions of the widely quoted gurus are usually contrary at this time. Place close stops when readings go above 1,20.
THE GLOBAL FUTURES MARKET TIMER INDEX0,801,001,201,4096-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18© SELLBUY
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Global Futures Fear Indicator
The Global Futures Fear Indicator is a proprietary indicator of Global Futures and not available anywhere else. It was unknown until now to the investment community and to our knowledge there is no previous mentioning of this indicator in any financial publication. The Global Futures Indicator gives buy signals when it has readings between 0 and 10.
Start buying good value stocks whenever the readings of this index fall below 0. This takes of course a lot of guts because the opinions of the widely quoted gurus are usually contrary at this time. Unfortunately this indicator does not tell you when to sell. Set yourself a limit if you trade options or use trailing stop-loss orders if you are a long-term investor.
THE GLOBAL FUTURES FEAR INDICATOR-5,000,005,0010,0015,0020,0025,0030,0035,0040,0096-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18© WallStreetCourier.comBUYPANIC
Wall Street Courier Index
The Wall Street Courier Index gives you a longer term picture of the stock market. Readings below 40 indicate a heavily oversold market which is ripe for an upturn. Readings above 50 flash a warning signal and you should use trailing stop-loss orders to protect your profits. This index serves longer-term oriented position traders very well. It is also a contrarian indicator and once again we would like to remind you that charts usually look most bullish at tops and most bearish at bottoms.This indicator has an excellent track record as you can see.
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THE WALL STREET COURIER INDEX0,350,400,450,500,550,6096-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18© WallStreetCourier.comBUYSELL
Global Futures Trading Index
The Global Futures Trading Index is a proprietary indicator of Global Futures. It shows bottoms and tops in trends and should be used together with the Global Futures Trend Index for exact timing. If the market is in a clear uptrend according to our trend index, go long if the Global Futures Trading Index shows a reading below 35. The reverse is true in a downtrend. Go short or buy puts if the index gives readings of 55 or above when the Global Futures Trend Index is below 20. Cover all your shorts if the index trades below 35 in a bearish trend. Please bear in mind that this index is a contrary indicator and therefore when these signals are given, they will be most likely contrary to most of the news of the moment and the opinions of the well known and most widely quoted gurus of Wall Street.
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THE GLOBAL FUTURES TRADING INDEX0,250,300,350,400,450,500,550,600,650,700,7596-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18© WallStreetCourier.comBUYSELL
Global Futures Speculation Index
This indicator is calculated by simply adding the number of the weekly CBOE equity calls and puts together and dividing the result by the weekly NYSE volume.
THE GLOBAL FUTURES SPECULATION INDEX0,600,801,001,201,4096-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18© WallStreetCourier.com Page 31
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Program Trading
Program trading is the purchase or sale of at least 15 different stocks with a total value of $1 million or more. Some of Wall Streets biggest names are the players in this game and they are among others: Merrill Lynch, Bear Stearns, First Boston, Morgan Stanley, Deutsche Bank Sec, and Nomura. There is a bullish tendency in the market whenever the Buy/Sell Ratio of program traders rises above 1,20 on a 4-week moving average. When program trading becomes excessive and accounts for more than about 25% of total volume on a 4-week moving average, the market became vulnerable in the past.
NYSE PROGRAM TRADING - BUY/SELL RATIO0,600,801,001,201,401,601,8096-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18© WallStreetCourier.com4 - WEEK MOVING AVERAGE PROGRAM TRADING IN % OF NYSE VOLUME 81420263296-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18© WallStreetCourier.com4- WEEK MOVING AVERAGE
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Global Futures Time Premium Index
The Global Futures Time Premium Index is a sentiment indicator. The spread between the S&P 500 cash index and the S&P futures contracts (premium) shows high readings near market tops and low readings near market bottoms. The bold red lines on the chart below show you the futures contracts with the highest and lowest premiums of the last years on a 5-day moving average for comparison (6 months until expiration). If the index (premium of the nearby S&P 500 futures contract on a 5-day moving average) moves close to the upper line or above, bullish sentiment is prevailing which is a bearish indicator. The reverse is true if the index moves near or below the lower line; it shows extreme pessimism by futures traders and indicates bottoms.
GLOBAL FUTURES TIME PREMIUM INDEX01020304050114112110108106104102100989694929088868482807876747270686664626058565452504846444240383634323028262422201816141108642© WallStreetCourier.comSP U1
Calendar Spread
A good sentiment indicator in the past has been the Calendar Spread . This is the premium spread of the two nearby S&P 500 futures contracts (for instance the difference between the June SP and September SP contracts on a 5- day moving average). It shows if futures traders are extremely bearish or bullish. When speculation peaked in June 2000 and everybody was bullish, this indicator was as high as 23!
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DAILY CALENDAR SPREAD71115192399-01-0699-02-0399-03-0399-03-3199-04-2899-05-2699-06-2399-07-2199-08-1899-09-1599-10-1399-11-1099-12-0800-01-0500-02-0200-03-0100-03-2900-04-2600-05-2400-06-2100-07-1900-08-1600-09-1300-10-1100-11-0800-12-0601-01-0301-01-3101-02-2801-03-2801-04-2501-05-2301-06-2001-07-18© WallStreetCourier.com5- DAY MOVING AVERAGE
Odd-Lot Differential Index
This index is simply calculated by subtracting the daily or weekly odd-lot sales from the daily or weekly odd-lot purchases. A 10-period moving average is applied to smooth out the swings. High readings appear near market tops and minus readings near bottoms. Introduced by Wall Street Courier, the Odd -Lot Differential Index indicates the market sentiment of small investors who purchase less than 100 shares of a stock. These market participants are usually wrong about the direction of the market and this indicator is therefore considered to be a contrary opinion sentiment indicator.
ODD-LOT DIFFERENTIAL INDEX DAILY-1000010002000300002.01.200105.01.200110.01.200116.01.200119.01.200124.01.200129.01.200101.02.200106.02.200109.02.200114.02.20010.02.200123.02.200128.02.200105.03.200108.03.200113.03.200116.03.200121.03.200126.03.200129.03.200103.04.200106.04.200111.04.20117.04.200120.04.200125.04.200130.04.200103.05.200108.05.200111.05.200116.05.200121.05.200124.05.200130.05.200104.06.200107.06.00112.06.200115.06.200120.06.200125.06.200128.06.2001© WallStreetCourier.com10-DAY MOVING AVERAGE Page 34
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Short Sales Statistics
The NYSE Short Interest Ratio
Every short seller anticipates a declining stock market. Investors sell short stock when they anticipate its price going lower. Sooner or later they must cover their short sales by buying back the stock. A profit is made if the stock is bought back at a lower price than when it was sold short. Indicators based on short selling statistics are an important part of technical analysis. Daily and weekly short sales are reported by the NYSE and published by financial sites all over the Internet. Market technicians watch the short selling activities of all the market participants very carefully. They distinguish between the odd-lots and the general public, the so called crowd, and the well informed NYSE members, specialists, floor traders and corporate insiders. When a large amount of short selling activity is occurring, market participants obviously expect prices to head lower. The NYSE Short Interest Ratio is therefore a long-term contrary opinion sentiment indicator. It is calculated by dividing the monthly short interest figure released by the New York Stock Exchange by the average volume of trading per day. These numbers get sometimes distorted by arbitrage transactions, but the short interest ratio is nevertheless a good indicator of optimism or pessimism in the market. Short sellers are potential buyers sooner or later and represent a lot of buying power when they have to scramble for cover in a sudden market turn. Contrary indicators require at least some degree of pessimism in order to function and therefore you should watch this ratio very carefully. THE NYSE SHORT INTEREST RATIO2468Jan96Mar96May96Jul.96Sep.96Nov.96Jan97Mar97May97Jul.97Sep.97Nov.97Jan98Mar98May98Jul.98Sep.98Nov.98Jan99Mar99May99Jul.99Sep.99Nov.99Jan00Mar00May00Jul.00Sep.00Nov.00Jan01Mar 01May 01© WallStreetCourier.com Page 35
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Odd-Lot Short Sales Ratio
The Odd-Lot Short Sales Ratio is calculated by dividing odd-lot short sales by the total number of short sales. For stocks, the generally accepted unit of trading is 100 shares (round lot). The Odd -Lot Short Ratio indicates the market sentiment of small investors who purchase less than 100 shares of a stock (odd-lot). These market participants are usually wrong about the direction of the market and this indicator is therefore considered to be a contrary opinion sentiment indicator.
ODD-LOT SHORT SALES RATIO0,000150,00020,000250,00030,000350,00040,0004596-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-1801-07-13© WallStreetCourier.comBUYSELL
Floor Traders Short Sales Ratio
The Floor Traders Short Sales Ratio is computed by dividing the total floor traders short sales by total short sales. A moving average should be applied to smooth out the swings. Floor traders are normally right about the trend of the market and if they are shorting heavily the market is usually ripe for a correction. On the other hand, if they are doing relatively little shorting it is most likely that the market has hit bottom, especially if public- and odd-lot short sales increase at the same time.
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FLOOR TRADERS SHORT SALES RATIO0,000250,000450,000650,000850,001050,001250,001450,0016596-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18© WallStreetCourier.com
Specialist Short Sales Ratio
Specialists are responsible for balancing incoming buy and sell orders to maintain orderly markets in the stocks in which they specialize. The Specialist Short Sales Ratio is computed by dividing the total specialist short sales by total short sales. A moving average should be applied to smooth out the swings. Specialists are normally right about the trend of the market and if they are shorting heavily the market is usually ripe for a correction. On the other hand, if they are doing relatively little shorting it is most likely that the market has hit bottom, especially if public- and odd-lot short sales increase at the same time. SPECIALISTS SHORT SALES RATIO0,300,350,400,450,500,550,6096-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18© WallStreetCourier.com Page 37
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NYSE Member Short Sales Ratio
The NYSE Members Report is compiled by the SEC and issued about two weeks after the applicable date. This indicator is a useful tool to determine what the experts are doing. The NYSE Member Short Sales Ratio is computed by dividing the total member short sales by total short sales. A moving average should be applied to smooth out the swings. Members of the NYSE are professionals and normally right about the trend of the market. If they are shorting heavily the market is usually ripe for a correction. On the other hand, if they are doing relatively little shorting it is most likely that the market has hit bottom, especially if public- and odd-lot short sales increase at the same time.
NYSE MEMBER SHORT SALES RATIO0,450,50,550,60,6596-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18© WallStreetCourier.com
Public Short Sales Ratio
The NYSE Members Report is compiled by the SEC and issued about two weeks after the applicable date. This indicator is a useful tool to determine what the public or the so called crowd is doing. The Public Short Sales Ratio is computed by dividing the total public short sales by total short sales. A moving average should be applied to smooth out the swings. The public is usually wrong about the trend of the market. If they are shorting heavily the market is usually ripe for an upturn. On the other hand, if they are doing relatively little shorting it is most likely that the market is near a correction, especially if specialists short sales increase at the same time.
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PUBLIC SHORT SALES RATIO0,350,40,450,50,5596-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18©
Odd-Lot Balance Index
This index is calculated by dividing daily or weekly odd-lot purchases by odd-lot sales. For stocks, the generally accepted unit of trading is 100 shares (round lot). The Odd -Lot Balance Index indicates the market sentiment of small investors who purchase less than 100 shares of a stock (odd-lot). These market participants are usually wrong about the direction of the market and this indicator is therefore considered to be a contrary opinion sentiment indicator.
ODD-LOT BALANCE INDEX DAILY0,801,001,201,401,601,8031.10.200007.11.200014.11.200021.11.200029.11.200006.12.200013.12.200020.12.200028.12.200005.01.20112.01.200122.01.200129.01.200105.02.200112.02.200120.02.200127.02.200106.03.200113.03.200120.03.200127.03.200103.04.200110.04.00118.04.200125.04.200102.05.200109.05.200116.05.200123.05.200131.05.200107.06.200114.06.200121.06.200128.06.200106.07.200113.0.200120.07.200127.07.200103.08.200110.08.200117.08.2001© WallStreetCourier.com10-DAY MOVING AVERAGESELLBUY Page 39
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Odd-Lot/Floor Trader Short Sales Ratio
This index is calculated by dividing the weekly odd-lot short sales by the weekly short sales by floor traders for better comparison. Introduced by Wall Street Courier, the Odd -Lot Short/Floor Trader Short Ratio indicates the market sentiment of small investors who purchase less than 100 shares of a stock (odd-lot). Unlike the more sophisticated floor traders, the odd-lotters are usually wrong about the direction of the market and this indicator is therefore considered to be a contrary opinion sentiment indicator.
ODD-LOT /FLOOR TRADERS SHORT SALES RATIO0,600,650,700,750,800,850,900,9596-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18© WallStreetCourier.comBUYSELL
Global Futures Odd-Lot/Specialist Short Sales Ratio
This index is calculated by dividing the weekly odd-lot short sales by the weekly specialists short sales for better comparison. A 4-week moving average is applied to smooth out the swings. Unlike the well informed specialists, the odd-lotters are usually wrong about the direction of the market and this indicator is therefore considered to be a contrary opinion sentiment indicator. High readings indicate heavy shorting by odd-lot investors and therefore bottoms, extremely low readings tops.
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ODD-LOT/SPECIALISTS SHORT SALES RATIO 0,00250,00550,00850,01150,014596-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18© WallStreetCourier.comBULLISHBEARISH
Global Futures Public/Member Short Sales Ratio
This index is calculated by dividing the weekly public short sales by the weekly member short sales for better comparison. A 4-week moving average is applied to smooth out the swings. Members of the NYSE are professionals and normally right about the trend of the market. If they are doing relatively little shorting it is most likely that the market has hit bottom, especially if public short sales increase at the same time. High readings indicate heavy shorting by the public (the so called crowd) and therefore bottoms, low readings indicate tops.
PUBLIC/MEMBER SHORT SALES RATIO 0,600,801,001,2096-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18© WallStreetCourier.comBULLISHBEARISH Page 41
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Public/Specialists Short Sales Ratio
The Specialist/Public Short Sales Ratio is a market sentiment indicator. It is calculated by dividing the volume of the weekly short sales made by the public (non members) by the weekly short sales made by stock exchange specialists (members). A 4-week moving average is applied to smooth out the swings. The public is usually wrong about the trend of the market. If they are shorting heavily the market is usually ripe for an upturn. On the other hand, if they are doing relatively little shorting it is most likely that the market is near a correction, especially if specialists short sales increase at the same time.
High readings indicate heavy shorting by the public (the so called crowd) and therefore bottoms, low readings indicate tops.
PUBLIC/SPECIALISTS SHORT SALES RATIO 0,701,101,501,9096-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18© WallStreetCourier.comBULLISHBEARISH
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Global Futures NYSE Member Trading Indicator
The NYSE Members Report is compiled by the SEC and issued about two weeks after the applicable date. This indicator is a useful tool to determine what the experts are doing. If specialists, floor traders and other members of the New York Stock Exchange are shorting heavily the market is usually ripe for a correction. On the other hand, if they are doing relatively little shorting it is most likely that the market has hit bottom, especially if public- and odd-lot short sales increase at the same time. Even if data are not quite up-to date, they are nevertheless an excellent indicator of the prevailing sentiment in the market. The formula of the Global Futures NYSE Member Trading Indicator is proprietary and we also use special moving averages to push the tops and bottoms forward an extra two weeks or so.
THE NYSE MEMBER TRADING INDICATOR-0,09-0,07-0,05-0,03-0,010,010,030,050,0796-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18BULLISHBEARISH© WallStreetCourier.com
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Sentiment Indicators
Investor Sentiment
The principles of Contrarian Investing hold that when the vast majority of people agree on anything, they are generally wrong. Otherwise no market would function because there is simply no minority with money enough to make a majority rich. A true contrarian, therefore, will first try to determine what the majority are doing and then will act in the opposite direction. Market Vane, AAII and Investors Intelligence are all contrary opinion indicators.
A unique feature of Market Vane's Bullish Consensus numbers is a weighting formula applied to the various market letters. More weight is given to letters with a larger following and less weight to those with fewer readers. Each week a poll of market letters is taken to determine the degree of bullishness or bearishness among futures professionals. The theory is that when a significant number of participants are bullish, they are already positioned on the long side and there is little potential buying power left. If most participants are bearish, selling pressure has reached an extreme and prices will reverse to the upside.
BULL/BEAR RATIO MARKET VANE2040608096-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-1801-07-13© WallStreetCourier.com10-WEEK MOVING AVERAGESELLBUY
Thanks to the Internet, the American Association of Individual Investors (AAII) now polls its 170,000 members daily. Respondents indicate how they feel about the
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market's performance in the next six months. The chart below shows the number of bulls divided by the number of bears. A 10-week moving average is applied to smooth out the swings. High readings appear near market tops and low readings near bottoms.
BULL/BEAR RATIO AAII0,601,101,602,102,603,103,604,1096-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18© WallStreetCourier.com10-WEEK MOVING AVERAGEBUYSELL
Since 1963, Investors Intelligence has been compiling data on the opinions of publishers of market letters. They conduct a weekly poll of about 130 market newsletter writers and calculate the percentage who are bullish, bearish or expecting a short-term correction. The resulting index shows that the advisory services follow the trend of equity prices by becoming most bullish near market tops and most bearish around market bottoms. BULL/BEAR RATIO INVESTORS INTELLIGENCE0,801,201,602,002,4096-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18© WallStreetCourier.com10-WEEK MOVING AVERAGEBUYSELL
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Commitments of Traders Report
The Commodity Futures Trading Commission (CFTC) provides inside information about purchases and sales of futures contracts. The largest players in each market are required to disclose their positions to the CFTC on a daily basis and this report is released weekly on Friday afternoon (the reporting requirement varies by commodity). These traders are separated into Commercial Hedgers and Large Speculators.
The positions of Small Traders are calculated by subtracting the total of contracts held by the reporting groups from all the contracts outstanding (Small Traders are not required to report their positions). Commercial Hedgers hold a significant informational edge over other traders as far as fundamental supply-and-demand statistics are concerned. They tend to be early, but they are usually right on the long run, quite contrary to the small traders. Extreme divergences in long and short positions of Small Traders, Large Speculators and Commercial Hedgers have proven to be reliable indicators of important trend changes. In such cases it is not advisable to bet against the Commercial Hedgers. All other patterns are meaningless. The following charts show you the positions of these three groups of market participants. A 10-week moving average is applied to smooth out the swings.
Three different charts are available for each commodity:
• Short positions of all market participants (Large Speculators, Commercial Hedgers, Small Traders) on a percentage basis.
• Short positions of Small Traders only. Significant changes in those numbers give you an insight about prevailing sentiment..
• The Long/Short Ratio of Small Traders. This chart is computed by dividing the long and short positions of Small Traders. High readings indicate heavy buying by Small Traders which is bearish.
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SOYBEANS - SHORT POSITIONS0,000,100,200,300,400,500,600,7096-11-2697-01-2197-03-1897-05-1397-07-0897-09-0297-10-2897-12-2398-02-1798-04-1498-06-0998-08-0498-09-2998-11-2499-01-1999-03-1699-05-1199-07-0699-08-3199-10-2699-12-2100-02-1500-04-1100-06-0600-08-0100-09-2600-11-2101-01-1601-03-1301-05-0801-07-03© WallStreetCourier.comCOMMERCIAL HEDGERLARGE SPECULATORSMALL TRADER10-WEEK MOVING AVERAGE SOYBEANS - SMALL TRADERS SHORT POSITION0,150,200,250,300,350,4096-01-0296-02-2796-04-2396-06-1896-08-1396-10-0896-12-0397-01-2897-03-2597-05-2097-07-1597-09-0997-11-0497-12-3098-02-2498-04-2198-06-1698-08-1198-10-0698-12-0199-01-2699-03-2399-05-1899-07-1399-09-0799-11-0299-12-2800-02-2200-04-1800-06-1300-08-0800-10-0300-11-2801-01-2301-03-2001-05-1501-07-10© WallStreetCourier.comBUYSELL SOYBEANS - SMALL TRADERS LONG/SHORT RATIO0,600,801,001,201,401,601,802,0096-01-0296-02-2796-04-2396-06-1896-08-1396-10-0896-12-0397-01-2897-03-2597-05-2097-07-1597-09-0997-11-0497-12-3098-02-2498-04-2198-06-1698-08-1198-10-0698-12-0199-01-2699-03-2399-05-1899-07-1399-09-0799-11-0299-12-2800-02-2200-04-1800-06-1300-08-0800-10-0300-11-2801-01-2301-03-2001-05-1501-07-10© WallStreetCourier.comBUYSELL Page 47
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Appendix
The enclosed charts of the indices have exactly the same time span as the charts in our e-book. You will therefore easily be able you to verify the reliability of each indicator.
Dow Jones Weekly Close
DOW JONES WEEKLY CLOSE5000600070008000900010000110001200096-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18© WallStreetCourier.com
S&P 500 Weekly Close
S & P 500 WEEKLY CLOSE600800100012001400160096-01-0596-03-0196-04-2696-06-2196-08-1696-10-1196-12-0697-01-3197-03-2897-05-2397-07-1897-09-1297-11-0798-01-0298-02-2798-04-2498-06-1998-08-1498-10-0998-12-0499-01-2999-03-2699-05-2199-07-1699-09-1099-11-0599-12-3100-02-2500-04-2100-06-1600-08-1100-10-0600-12-0101-01-2601-03-2301-05-18© WallStreetCourier.com Page 48
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Risk Statement
HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN. IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING PROGRAM. ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK IN ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL OF WHICH CAN ADVERSELY AFFECT ACTUAL TRADING RESULTS.” TRADING IN COMMODITY FUTURES OR OPTIONS INVOLVES SUBSTANTIAL RISK OF LOSS.
THIS RISK STATEMENT APPLIES TO ANY ILLUSTRATION OF PROFIT AND LOSS CONTAINED WITHIN THIS PUBLICATION. IT SHOULD ALSO BE NOTED THAT STOP LOSS ORDERS DO NOT NECESSARILY LIMIT LOSSES OR LOCK IN PROFITS.
DEPENDING UPON MARKET CONDITIONS, STOP LOSS ORDERS MAY BE EXECUTED AT PRICES SUBSTANTIALLY BELOW OR ABOVE THE SPECIFIED STOP PRICE.

The Day Trade Forex System:The ULTIMATE Step-By-Step Guide to Online

2007-08-25T18:23:00.001-07:00

The Day Trade Forex System:
The ULTIMATE Step-By-Step Guide to Online
Currency Trading
“How You Can Earn $50 to $500 A Day Currency Trading
From The Comfort of Your Own Home!”
By Erol Bortucene and Cynthia Macy
RISKS DISCLAIMER
Erol Bortucene/Cynthia Macy, Owners of DayTradeForex.com and any of their affiliates, will not be held responsible for
the reliability or accuracy of the information available in this document. The content provided is put forward in good
faith and believed to be accurate, however, there are no explicit or implicit warranties of accuracy or guarantees
that the readers of this course will make profits trading Currencies. The reader agrees not to hold Erol Bortucene
or Cynthia Macy, or any of its affiliates, liable for decisions that are based on information from The Day Trade
Forex System.
Margined Currency Trading is an extremely risky form of investment and is only suitable for individuals and institutions
capable of handling the potential losses it entails. The funds in an account that is trading at maximum leverage may be
completely lost if the position(s) held in the account experiences one percent swing in value. Given the possibility of
losing one's entire investment, speculation in the foreign exchange market should only be conducted with risk capital
funds that, if lost, will not significantly affect the investor’s financial well-being. There is no guarantee that readers of this
document or our websites will make money. Readers use the information and links entirely at their own risk. Erol
Bortucene/Cynthia Macy owners of DayTradeForex.com do not accept any liability in respect of any loss or damage
arising from or in connection with any use of the information on or accessed through this document or our company
websites. All intellectual property rights in this report remain the property of DayTradeForex.com
© 2002, 2003 Copyright DayTradeForex.com
© 2003 Copyright DayTradeForex.com
All Rights Reserved. No Part of this publication may be reproduced or transmitted in any form or by any means,
electronic, mechanical, recording or otherwise without the prior permission of DayTradeForex.com
1
The Day Trade Forex System:
The ULTIMATE Step-By-Step Guide to Online
Currency Trading
“How You Can Earn $50 to $500 A Day Currency Trading
From The Comfort of Your Own Home!”
Did you know that more and more business opportunity seekers worldwide are
discovering the powerful profit potential of Foreign Exchange trading? In this
business, there are no employees to hire, no advertising, no products to stock,
no downlines to fill--just you, an Internet connection and a computer. That's all
you need to make money on the worlds largest market. If you are searching for
an alternative to more traditional home-based business opportunities, then Forex
trading may be what you’ve been looking for.
Our purpose is to empower, mentor and train currency traders all around the
world who would like to Day Trade Forex as their main source of income. For
those looking for a significant part-time income, we believe Currency Trading is
the vehicle to use. Our aim is to assist you to:
1. Stay Disciplined—To learn how to manage risk effectively.
2. Keep Objective—To trade in a non-emotional, intelligent way.
3. Trade with Confidence—To know exactly when to trade.
4. Become Systematic—To generate your own Forex buy/sell signals.
The goal is to earn $50 to $500 per trade and minimize losses on losing trades
using technical indicators on charts, which I will explain later on in this course.
The potential to profit is there for those who trade this system. The great thing
about Forex trading is that you can test this system for FREE on a demo account
using virtual money, before you risk one penny on actual trades.
You will be able to join my team of traders as you advance step-by-step through
this guide. We will begin by explaining what Forex is and all the benefits of
trading currencies
2
WHAT IS FOREX
The Foreign Exchange, also referred to as the "Forex" or "Spot FX" market, is
the largest financial market in the world, with over $1.2 trillion changing hands
every single day. If you compare that to the $25 billion a day volume that the
New York Stock Exchange trades, you see how giant the Foreign Exchange
really is. In fact it is three times larger than all of the US Equity and Treasury
markets combined!
What is traded on the Foreign Exchange? The answer is money. Forex trading
is where the currency of one nation is traded for that of another. Therefore,
Forex trading is always traded in pairs. The most commonly traded currency
pairs are traded against the US Dollar (USD). They are called ‘the Majors'. The
major currency pairs are the Euro Dollar (EUR/USD); the British Pound
(GBP/USD); the Japanese Yen (USD/JPY); and the Swiss Franc (USD/CHF).
The notable ‘commodity’ currency pairs that trade are the Canadian Dollar
(USD/CAD) and the Australian Dollar AUD/USD. Because there is not a central
exchange for the Forex market, these pairs and their crosses are traded over the
telephone and online through a global network of banks, multinational
corporations, importers and exporters, brokers and currency traders.
Traditionally, currency trading has been a 'professionals only' market available
exclusively to banks and large institutions, however, because of the rise of the
new E-economy, online Forex trading firms are now able to offer trading
accounts to 'retail' traders like you and I. Now almost anyone with a computer
and an Internet connection can trade currencies just like the world's largest
banks do. There are now over 6 million trading accounts worldwide up from 1.7
million in 1997.
BENEFITS OF FOREX TRADING
There are many benefits and advantages to trading Forex. Here are just a few
reasons why so many people are choosing this market as a business
opportunity:
1.LEVERAGE: In Forex trading, a small margin deposit can control a much
larger total contract value. Leverage gives the trader the ability to make
extraordinary profits and at the same time keep risk capital to a minimum. Some
Forex firms offer 200 to 1 leverage, which means that a $50 dollar margin
deposit would enable a trader to buy or sell $10,000 worth of currencies.
Similarly, with $500 dollars, one could trade with $100,000 dollars and so on.
2.LIQUIDITY: Because the Forex Market is so large, it is also extremely liquid.
This means that with a click of a mouse you can instantaneously buy and sell at
3
will. You are never 'stuck' in a trade. You can even set the online trading
platform to automatically close your position at your desired profit level (limit
order), and/or close a trade if a trade is going against you (stop order).
3.PROFIT IN BOTH 'RISING' AND 'FALLING' MARKETS: On the stock
markets, you can only make money if shares are rising, but in economic
recession and falling 'bear' markets, there is little chance of making big money.
Forex is different. One of the most exciting advantages of FX trading is the ability
to generate profits whether a currency pair is 'up' or 'down'. A trader can profit
by taking a 'long' position, (buying the currency pair at one price and selling it
later at a higher price), or a 'short' position, (selling the currency pair and buying
it back at a lower price). For example, if you think the US dollar will increase in
value vs. the Japanese Yen then you will buy Dollars and sell Yen (go long). If
you think the Yen will increase in value against the Dollar then you will sell
Dollars and buy yen (go short). As long as the trader picks the right direction, a
potential for profit always exists.
4. 24HRS: From Sunday evening to Friday Afternoon EST the Forex market
never sleeps. This is very desirable for those who want to trade on a part-time
basis, because you can choose when you want to trade--morning, noon or night.
5. FREE 'DEMO' ACCOUNTS, NEWS, CHARTS AND ANALYSIS: Most Online
Forex firms offer free 'Demo' accounts to practice trading, along with breaking
Forex news and charting services. These are very valuable resources for traders
who would like to hone their trading skills with 'virtual' money before opening a
live trading account.
6.'MINI' TRADING: One might think that getting started as a currency trader
would cost a lot of money. The fact is, it doesn't. Online Forex Firms now offer
'mini' trading accounts with a minimum account deposit of only $200-$500 with
no commission trading. This makes Forex much more accessible to the average
individual, without large, start-up capital.
4
The Day Trade Forex System
Foundations:
Before we begin looking at the specifics of the FPS and how it works, let’s look at
4 building blocks that I believe to be foundations to the Forex Profit System.
 Foundation #1: Currency Trading is not a Get-Rich-
Quick Scheme.
Currency trading is a SKILL that takes TIME to learn. Skilled Traders
can and do make money in this field, however like any other occupation or
career, success doesn’t just happen overnight. Here is a great ‘formula’
for success:
Practice + Patience + Persistence = Profits
As they say, there is no substitute for hard work and diligence. Practice
trading on a demo account and pretend the virtual money is your own real
money. Do not open a live trading account until you are profitable
trading on a demo account. Stick to the plan and you can be
successful.
 Foundation #2: I highly recommend that you follow 1 or
maybe 2 major currency pairs.
It gets far too complicated to keep tabs on all four. I also recommend that
traders choose one of the majors because the spread is the best and they
are the most liquid. The Euro/USD is the most commonly traded pair and
usually has the best ‘spread’ because of its liquidity. The USD/Swiss Franc is
usually the most volatile and moves the most during the trading week. The
USD/Yen moves a lot on the news out of Japan and normally the Pound
Sterling/USD is more stable in it’s moves than the other three.
5
 Foundation #3: Follow and understand the daily Forex
News and Analysis of the professional currency
analysts.
Even though this system is based solely on technical analysis of charts, it is
important to get a birds-eye view of the currency markets and the news that
affects the prices. It is also important that you know and understand what the
key technical ‘support’ and ‘resistance’ levels are in the currency pair that you
want to trade. Support is a predicted level to buy (where currency pair should
move up on the charts), resistance is a predicted level to sell (where the
currency pair should move down on the charts).
Fortunately, all the best Forex news and analysis is offered free on the
Internet. Here is what you should do first:
*While you are reading the daily news and technical analysis, write
down on a piece of paper what direction the analysts are saying
about the major currency pair you are following and the key support
and resistance levels for the day.
A. Go to www.forexnews.com and you will find 24hr news and analysis on
the spot FX markets. The site will give you the big picture of how the
economic calendar and central banks affect the currency markets. A
great resource.
B. Then go to www.fxstreet.com and click on the ‘Top Forex Reports’. Here
there is a wonderful listing of all the major daily currency analysis and
forecasts with support and resistance and direction forecasts.
C. Click on www.currencypro.com and go to ‘Today’s Market Research’ and
there you will find more excellent analysis on the Major Currency pairs.
Another great Forex Portal.
 Foundation #4: Learn how to use the technical
indicators in this course and always trade with stop
losses!
It is worth your time to be patient and learn how to use the technical
indicators on the charts that you will be reading about shortly.
6
It is important when you are trading Forex, to be disciplined and to stick to
a plan. Don’t just trade your ‘gut’ feeling. Use the technical indicators
outlined and always enter in stop losses on every trade. Remember that
everyone who trades has a different tolerance for losses. Depending on
your risk capital, and strategy, set your stop losses accordingly.
7
The Day Trade Forex System:
Six Steps to Success
The goal of this guide is to instruct and teach potential traders how to day trade
the currency markets. The objective of day trading is to trade the intra day
market moves to try to gain small to medium sized profits in any given trading
day. This is how this guide will help. Most readers will not have the time or
resources to ‘position trade’ like the major institutions and banks do. They tend
to look at the big picture holding onto trades for weeks or months.
The Forex Profit System is specifically designed for use with the 1, 5 or 10
minute charts, with the goal of taking 5-20 pip profits per trade—closing
bad trades out using tight stops, or hedging any losing trades. The
following steps will show you how to do this.
Step 1. Choose an online Forex Firm
What to look for in an online Forex Firm:
1. Low Spreads.
In Forex Trading the ‘spread’ is the difference between the buy and
sell price of any given currency pair. The lower the spread saves
the trader money. Most firms offer 4-5 pip spreads in the Major
Currency pairs. The best firms offer clients 3-5 pips.
2. Low minimum account openings.
For those that are new to trading, and for those that don’t have
thousands of dollars in risk capital to trade, being able to open a
mini trading account with only $200 is a great feature for new
traders.
3. Instant automatic execution of your orders.
This is very important when choosing a Forex firm. You want instant
execution of your orders and the price you see and ‘click’ is the price
that you should get. Don’t settle with a firm that re-quotes you when
you click on a price or a firm that allows for price ‘slippage’. This is
very important when trading for small profits.
8
4. Free charting and technical analysis
You need a firm that gives you access to the best charting and technical
analysis available to active traders. The firm that I recommend gives
clients FREE professional charting services and even allows traders to
trade directly on the charts!
5. High Leverage
You want high leverage—the ability to trade a large amount with a small
margin deposit. Some of the best firms offer .25% or 400:1 leverage.
6. Hedging Capability
You want the flexibility of opening positions on the same currency pair in
opposite directions without them eliminating each other and without
margin increase!
Here is a list of some of the main Forex trading Firms on the Internet. After a lot
of research and personal experience, the firm that I recommend with the abovementioned
benefits is Capital Markets Services LLC (CMS Forex LLC). You can
research the rest of the firms listed to see for yourself.
**CMS Forex www.cms-forex.com
ACM Advanced Currency Markets
Fairlot Financial Group
Forex Capital Markets
GAIN Capital
GCI Financial, Ltd.
Global Forex
IFX Markets Limited
London Capital
Meridian Forex Pty Limited
MG Financial Group
SaxoBank
Tricom
9
Step 2. Open a ‘Visual Trading’ Demo Account
The first step to trading the currency markets is to open a demo account. It is
important that you learn how to buy and sell the currency pairs, set stop losses,
set profit limits, and understand how leveraged margin works when you trade. I
found the best way to learn this is by experience.
To set up your FREE charting from CMS, simply go to their website and open a
‘Visual Trading’ Free demo account. The charting package in this demo account
rivals, any Forex Professional charting service and you will be able to set up the
technical indicators that will aid you in your trading decisions.
A. Go to http://www.cms-forex.com and click on the ‘Sign Up’ tab and scroll
down to Visual Trading Demo. Open up a free demo account and you will
get your log in information sent to your email address.
B. Now go to the ‘Support’ Tab and scroll down to ‘Visual Trading Manual’.
This manual will show you how the trading platform works. You will need
to read this before proceeding. The better you know your way around
this platform, the easier the next steps will be.
10
Step 3: Set up your charts:
A. One the left hand side of screen you will be able to choose your chart.
Choose EUR/USD (or whatever currency pair you like) , 5 min, line and
the chart will appear on the right hand side. Maximize the chart to fill the
right hand side.
Your chart should now look something like this:
11
Now if you want to make the price line darker, you can right click right on the
price line and a properties box will appear. You can adjust the thickness of the
line. In this example the price line width is set it to 2.
B. Before we add our studies to our charts, I would like you to go to the
following links. Read how to trade the Parabolic SAR here:
www.incrediblecharts.com/technical/parabolic_sar.htm
Read about how to trade moving average crossovers here:
www.incrediblecharts.com/technical/moving_averages_three.htm
Read about how to trade Bollinger Bands here:
www.incrediblecharts.com/technical/bollinger_bands.htm
*We will be giving examples of how to apply these studies to day
trading Forex.
12
C. Now we will add the Moving Averages to the chart. We will be using the
Exponential Moving Average 10, the Bollinger Band Exponential Set at
20, and the Exponential Moving Average 50.
Click on Moving Average on the left hand side under Studies. Set
your first MA to 10, close, exponential and you can make it red with
line width 2 under the Color/Style Tab.
Click on Moving Average again and add your MA 50, close,
exponential and make this line blue with line width 2.
Here is a shot of the Moving Average Properties window:
D. Now go to the studies on the left hand side of your screen Select
Bollinger Bands and set them to 20,2, close exponential. Make the
middle band green, line width 2.
E. Add Parabolic SAR to your chart by selecting it on the left and use the
default settings. Make the dots darker, by selecting line width 2.
13
Your chart should now look like this:
You can zoom in and out of your chart using the small buttons in the bottom right
hand side of your screen.
How To Change the Currency Pair and Time Frame:
On the bottom of your chart, you can change the currency pair and right beside
it, if you click on the button that says M5 you can change the time frame of the
chart. The studies will automatically be added to any new time frame and
currency pair that you select.
How to Exit the VT Platform Properly:
To exit the VT platform, click on FILE and then EXIT. The studies that you
added to your chart will automatically be up the next time that you log in to your
account. Please note that if you click x on the top left hand corner of your chart
you will close the chart and reset your settings that you added. If you want to
keep your studies and charts intact you can minimize it or just leave always
keep it open to keep your settings saved.
14
F. Now we will add 3 more indicators below the chart to help us confirm the
trend, and to help us identify exact entry and exit buy or sell signals. The
following indicators give us insight into the momentum, direction and
overbought/sold indicators. Used along with the Exponential Moving
Averages, Parabolic SAR and Bollinger Bands—these indicators can be
very helpful to the day trader.
MACD Histogram.
Read about how to trade the MACD Histogram here:
http://www.incrediblecharts.com/technical/macd_histogram.htm
Relative Strength Index (RSI)
Read about how to trade the RSI here:
http://www.incrediblecharts.com/technical/relative_strength_index.htm
Slow Stochastic
Read about how to trade the Slow Stochastic here:
http://www.incrediblecharts.com/technical/slow_stochastic.htm
Now add these studies to your charts.
Under Studies click on MACD Histogram and use the default settings
(9,Exponential, 12, 26, Close, Exponential) and set the line width to 2.
Your study will automatically open under your chart.
Under Studies click on Relative Strength Index and set it to 14 and set
the line width to 2. Your study will automatically open under your chart.
Under Studies click on Slow Stochastic and set it to (5,3,3, Exponential)
and make the %K line blue with line width 2, and the %D line red with line
width 2.
Your chart, with all the studies on it should now look like this (example of
USD/CAD 10 min chart): Notice that I clicked on the zoom in button a couple of
times on the bottom right hand corner to get it to look like this.
15
Step 4: How to Buy and Sell the Currency Pairs
Now that our charts are set up, let’s learn HOW to open and close a position, or
buy and sell on the VT platform. After we learn HOW, we can look at WHEN to
enter/exit a trade using the technical indicators. **Please note that this
information is in the Visual Trading Manual that you should have already
read.
A. Simply move your cursor to the chart and right click. A menu will pop up
and at the top it will say buy with the current exchange rate to buy and
sell with the current exchange rate to sell. You should Buy if you think the
price line will go up on your chart or sell when you think the rate will drop
16
on the chart. Click on buy or sell and an ‘Open Positions’ window will pop
up that looks like this:
B. In the Amount per Acct: box you put in how many lots you will trade—1 lot
is 100,000 currency units.
Trading with 1 lot EUR/USD is $10 profit/loss per pip
Trading with 1 lot GBP/USD is $10 profit/loss per pip
Trading with 1 lot USD/JPY is $8 profit/loss per pip
Trading with 1 lot USD/CHF is $6 profit/loss per pip
Trading with 2 lots doubles the profit/loss possibility. Trading with .5 of a lot
halves the profit/loss possibility. With the CMS universal account you can
trade full or partial lots from this window. If you put in .1 of a lot your
profit/loss would be $1 in the EUR/USD etc…
C. The trade that you just made will now show up directly on the chart. If you
right click your open position on the chart you can choose to add a Stop
price and a Limit price, or you can hedge your position—which we will look
at later on.
Stop Order: Is a price you enter into an open position, where the trading
platform automatically closes your position when the Exchange rate touches
that level. If you are in a winning trade, you can move your stop up or down
17
to protect profits. If the exchange rate never hits that level, then the Order
doesn’t get filled.
**tip: If you are in a winning trade, you can move your stop to your entry
level, so that if your trade moves against you, the platform closes your
position without any losses.
**tip: You should be comfortable setting your stop Order at 15-20 pips. If
you can’t handle a 15-20 pip loss, then you are need to trade smaller
amounts. This will help you from over leveraging your trading account.
Limit Order: Is a price you enter into an open position for the trading
platform to automatically close your position at a profit. For example, you
might set your limit order at a 15 pip profit. If the exchange rate never hits
that level, then the Order doesn’t get filled.
Step 5: When to Enter and Exit Your Trades:
We will be looking at 3 different ways to day trade the Forex Markets. In a
trading session, you may look for 1 or more of these approaches. The 3
techniques are as follows:
1. Trade the Breakout
2. Trade the Trend
3. Trading Tops and Bottoms
Before we look at these trading approaches, let’s answer a question that is often
asked by new traders.
When is the best time to trade?
Because the Forex Market is open 24hrs a day, and traded on a global scale, the
question to ask is, ‘when should I trade?’. The good news is that no matter what
time zone or hemisphere you live in globally, there are always good opportunities
to trade.
The three major trading ‘sessions’ are as follows (all in Eastern Standard Time):
1. New York open 8:00 AM to 4:00 PM
2. Japanese/Australian open 7:00 PM to 3:00 AM
3. London open 3:00 AM to 8:00 AM
**Often, the best times to trade is at the beginning 3-5 hours of the above
mentioned opening times, because the major currency pairs tend to move
the most in a particular direction.
18
The first DayTradeForex.com trading technique we will look at is the easiest to
recognize on the charts. We will call it ‘Trade the Breakout’. You can use the 5,
10 or 15 minute charts for this method. The indicators on the 5 minute charts
are the fastest. Practice until you feel comfortable with the time frame that suits
you best.
1. Trade the Breakout
The principle behind trading the breakout is to enter a trade when the price
‘breaks out’ of a tight range, because often it tends to keep moving in the
same direction. We use our Bollinger Bands on our charts to spot this trading
opportunity. See screenshot on next page.
19
In the above example, EUR/USD 5 min chart, notice how the Bollinger Bands
tighten and squeeze together. When this happens you know that there is a
Breakout coming. As soon as the exchange rate line (brown), breaks out of
the outside Bollinger Bands, it signals your entry buy/sell. In this case if you
bought EUR/USD at 1.1815 and Closed your position at 1.1840 , you could
have made a fast 25 pip profit.
Notice the confirming indicators: The exchange rate line (brown) is above
the EMA 10 (red), the middle BB line (green) and the EMA 50 blue. The
Parabolic SAR dots are on the bottom.
The MACD Histogram is above 0 signaling upward momentum. The RSI is
above 50 signaling upward momentum, and the Slow Stochastic blue line is
above the red line signaling bullish momentum.
20
Here is an example of EUR/USD 5 minute breakout SELL. You could have sold
the EUR/USD at 1.1440 and closed your position at 1.1390 for a 50 pip profit.
Notice the confirming indicators: The exchange rate line is below the EMA
10 (red), the middle BB line (green) and the EMA 50 blue. The Parabolic
SAR dots are on the top.
The MACD Histogram is below 0 signaling downward momentum. The RSI
is below 50 signaling downward momentum, and the Slow Stochastic blue
line is below the red line signaling bearish momentum.
21
Here is an example of USD/CAD 10 min chart. If you bought this currency pair
at 1.3590 when it broke out of the bands and sold it at 1.3620 you could have
made approximately 30 pips.
The exchange rate line (brown) is above the EMA 10 (red), the middle BB
line (green) and the EMA 50 blue. The Parabolic SAR dots are on the
bottom.
The MACD Histogram is above 0 signaling upward momentum. The RSI is
above 50 signaling upward momentum, and the Slow Stochastic blue line is
above the red line signaling bullish momentum.
22
Here is a USD/CHF 5 min chart example of a breakout SELL. Notice how the
MACD Histogram went from positive to negative, and how the other confirming
indicators signaled SELL.
The exchange rate line is below the EMA 10 (red), the middle BB line (green)
and the EMA 50 blue. The Parabolic SAR dots are on the top.
The MACD Histogram is below 0 signaling downward momentum. The RSI is
below 50 signaling downward momentum, and the Slow Stochastic blue line is
below the red line signaling bearish momentum.
23
Here was an extreme breakout EUR/USD BUY where you could have held on for
a 100 pip morning!
Again, The exchange rate line (brown) is above the EMA 10 (red), the middle
BB line (green) and the EMA 50 blue. The Parabolic SAR dots are on the
bottom.
The MACD Histogram is above 0 signaling upward momentum. The RSI is
above 50 signaling upward momentum, and the Slow Stochastic blue line is
above the red line signaling bullish momentum.
24
The second DayTradeForex.com trading technique uses the same principles, but
is less extreme. This trading method is best traded on the 5 or 10 min charts,
but can be applied to the 1 minute charts (See the Bonus “Micro Trading”
strategy at the end of this trading course)
2. Trade the Trend
Trading the trend is just like trading the breakout, except in less volatile
market conditions. Start with going to the 15 minute chart of the currency
pair of your choice and ask yourself this question: ‘Is the exchange rate line
(brown) above or below the EMA 50 (blue)?
**If the price line is currently below the EMA 50, and the EMA 10 and BB 20
are also below the EMA 50, then you will be looking at Selling opportunities
in the trading session.
If the price line is currently above the EMA 50, and the EMA 10 and BB 20
are above the EMA 50, then you will be looking at buying opportunities in the
trading session.
Often, when you are ‘trading the trend’, you will notice that the price line will
bounce off the EMA 10 or the middle BB line or the EMA 50. These lines
sometimes act as supports and resistances in a trading session. Therefore
you can look to sell shorts when the price line bounces down off the EMA
10, BB 20 or EMA 50, or buy longs when the price line bounces up off the
EMA 10 BB 20 or EMA 50.
When you trade the trend, it is important to trade with the Parabolic SAR,
MACD, RSI and Slow Stochastic all signaling together.
25
The above example is a 5 minute EUR/USD chart. The first thing to look for is
the EMA 50 blue line. Notice that it has been above the price line and the EMA
10 and BB 20. You will now be looking to SELL. Notice how the price line
bounced down off of the EMA 10 and BB 20 right before I circled the chart.
Now look at your other indicators:
The MACD Histogram turned down below zero, RSI turned down below 50
and Slow Stochastic blue line turned down under the red line. This would
have been a good signal to Sell Short—you could have profited at least 20 pips
on this trade.
26
The above example is a 10 minute EUR/USD chart. The first thing to look for is
the EMA 50 blue line. Notice that it has been below the price line and the EMA
10 and BB 20. You will now be looking to BUY.
Notice how the price line crossed down through the EMA lines prior to the
circles. This would have been a false signal to sell because the EMA 10 and BB
20 were above the EMA 50. If you were looking at buying opportunities then you
could have entered when the price continued to rise where I circled on the chart.
Now look at your other indicators:
The MACD Histogram turned up above zero, RSI turned up above 50 and Slow
Stochastic blue line turned up above the red line. This would have been a
good signal to Buy long—you could have profited at least 30 pips on this trade.
27
Here is an example of anticipating the trend. The market, previously rejected the
breakout rise in price and turned the other way sharply. If you entered this trade
when the MACD Histogram turned down into negative territory and the RSI
moved below 50, you could have anticipated the trend before the EMA 10 and
the BB 20 moved below the EMA 50.
28
The third DayTradeForex.com trading strategy that we are going to look at in this
guide is:
3. Trading Tops and Bottoms
Trading tops and bottoms can be more risky that the other two strategies
because you are trading against the trend anticipating the market is
overbought/oversold and might turn in the other direction. It is best to use
the 10 or 15 minute charts for this method. It is more risky using the 5 min
charts, but you still can apply the same techniques.
29
Here is an example of a EUR/USD 15min chart, bottom buy.
Notice how the MACD histogram is starting to rise, and the RSI is turning up
from being oversold and the slow stochastic blue line crossed the red line and
is turning up from oversold.
30
Here is a 5 minute chart example with EUR/USD. Notice the MACD, RSI and
Slow Stochastic move up from oversold at 8:30. At 10:30 you could have sold
short for a small profit.
Trading tops and bottoms is best in ranging markets.
31
Here is an example of a breakout SELL and a Bottom BUY in a trading session
watching the USD/JPY 10 minute charts. This bottom BUY is a great example of
oversold indicators with RSI and with Slow Stochastic.
When to EXIT trades
The goal of this day trading guide is to teach traders to take 5-20 pip profits at a
time. You can set profit LIMIT orders to achieve this, or you may want to move
your stops as your position becomes more and more profitable.
**Make sure that you don’t let a winning trade become a losing one, by using
trailing stop orders.
32
How to use HEDGING to your advantage
Hedging can be a useful tool to the Forex trader. When you have an open
position, for example, you are long on a USD/JPY trade and you right click your
trade on the VT platform, a menu will pop up and you have a choice to Hedge
your trade. If you click Hedge, you will automatically open up a position in
the opposite direction at the current market price without canceling out
your other position and without margin increase!. In the above example you
would now have a USD/JPY trade long and short. You will now neither gain or
lose any equity in your account because the gains and the losses will cancel
each other out.
Hedge in an emergency: Hedging a losing trade won’t solve your problems, but
it will 1. Keep you from more losses 2. Give you time to think about what
happened to your bad trade and 3.Give you a second chance. Some traders will
hedge losing trades instead of stopping out there position, because they have a
chance to win back the losses of the original bad trade.
Example: You are looking to ‘Trade the Trend’ so you go long on the
EUR/USD, using the indicators in this guide. The indicators signaled BUY
so you opened up a position. In case of a bad trade, you choose to
hedge instead of using a stop loss (be careful when doing this). Your
‘Trade the Trend’ indicators didn’t work and your position goes against
you, you hedge your trade. Now you have a losing position and a winning
position going in the opposite directions. You didn’t use up any more
margin. What do you do now?
My recommendation: When your position is hedged, you are safe and
you won’t lose any more money in your account. Here is what you should
do:
1. Wait until another chart set up occurs and proceed to step 4. or Exit
the trading platform.
2. Wait till the next trading day or session
3. Look for the DTF indicators the next day.
4. Instead of opening up another position, simply get rid of the bad
position that was hedged. So if the indicators the next day signaled
long in the EUR/USD, like in the above example, then you would get
rid of the short, losing hedge and hope that the price will rise enough
to erase the previous days losses to make a profit.
5. If your position moves against you again you can hedge that position
again and repeat steps 1-4.
Hedge a winning trade: You may also hedge a winning trade to protect your
gains, if you don’t want to completely close your position. When you do this you
won’t gain or lose any more money with that position. The advantage to this
33
would give you the opportunity to keep trading those positions in the future and
give you a break. You can always right click on your position and choose ‘close
with hedge’ to close both positions at once. If you hedge a winning position you
can follow the above steps 1-4 to keep trading your position the next trading day.
** Please note that hedging can get complicated. Try to keep it as simple as
possible and try not to have a web of hedged and unhedged positions open at
the same time—as it becomes exponentially more difficult to keep track of, and
what positions to let go etc...
** Hedging is also optional and you don’t need to learn how to use this tool if you
choose not to. You can be a successful trader by simply using stop and limit
orders.
Understanding Risk Management
Understanding risk management is a very important reality when trading the
Forex Markets. Losing trades will happen, and managing those losses are the
key to success. A good rule of thumb when setting your stop losses is the 5-7%
rule. If your trading account is at $2000, then set your stop loss so that you don’t
lose more than 5-7% of the total value of your account. If you used this rule in
this case, you would stop out a losing trade when you were down $100-$140.
This is important, because if you don’t manage your losses well, you can easily
lose 50% of your trading account on 1 bad trade. You do that a couple of times
and you will lose all of your risk capital. It is better to take smaller losses and try
to maximize your winning trades. So be careful and deliberate when setting your
stops on your trading platform.
Step 6. Open a Live trading account
Now that you understand the basics and have been demo trading awhile, you
are now ready to open a live trading account and join the Day Trade Forex
trading team.
If you have found this step-by-step currency-trading guide useful and helpful and
if you decide to open up a live trading account through me (co-owner of
DayTradeForex.com), I will personally give you the customer service and support
to assist you with your new account (my service will NOT cost you any extra
money.) Here is how you open a live trading account.
34
Open a live account online by clicking HERE NOW. To open a live
account offline, follow the directions on next page.
1. Go to www.cms-forex.com and under the Sign Up Tab on the top, scroll
down to Live Account Sign Up. Under IB-Reffered Individual ( In the circle
on the bottom of the picture) , follow the instructions.
2. When filling out your CMS forms, simply use my name (Erol Bortucene)
as the third party that referred you. This is on page 23 of the CMS
application. If you decide to use the online application, please print out
page 23, print my name on the top and sign it at the bottom and fax it to
CMS. Using my name as your referrer is FREE and doesn’t cost you any
commission at all.
35
3. On the bottom of page 23 (of the CMS application). where it reads:
________________________________________________________
10. Client understands and agrees that there may be commission
implemented on his account. If such commission is added, its size is the
following (in USD or another base currency):
Universal Account: Commission per one 100K lot _______;
and/or per one 10k mini lot _______; Professional Account:
Commission per one 250k lot _______Exclusive Mini Account:
Commission per one 10K lot ______
_______________________________________________________
Simply put the number ‘0’ in the blanks as I will not be charging you any
commission as your introducing broker (IB). Sign and fax this to CMS
along with your other information and forms. Thank you kindly. For
questions or assistance with opening your live account you can contact
me at bortucene@ziplip.com
Keep a trading journal
Finally, it is a good practice to keep a simple trading journal. This way you can
keep track of your trades and progress and be able to analyze, improve and
hone your trading skills.
Simply include the time you entered and exited the trade, the Currency pair, the
chart time frame (this is important), and the strategy (breakout, trend or top or
bottom). Also include write down what happened and what you could have
done differently for future reference.
36
Useful Links
www.moneytec.com
Free Forex trading forum.
www.forexdirectory.net,
Comprehensive listing of everything, related to the Forex Markets.
www.mgforex.com/resource/glossary.asp
A good Forex Glossary
Before we present you with our exciting, new “Micro Trading” strategy, we would
like to warmly invite you to order our DayTradeForex.com Advanced Trading
Course. We strongly advise you to learn the techniques in our advanced course
before you open a live account. You can read about it here:
http://www.daytradeforex.com/advanced.htm
Happy Trading!
The Day Trade Forex Team
For questions or assistance please contact us at:
support@daytradeforex.com
BONUS: “Micro Trading” the 1 minute Charts
See next page...
37
“Micro Trading” the 1 minute Charts
Now that you have opened a demo account and familiarized yourself with the VT
trading platform we would like to introduce you to the Forex trading technique of
'scalping' for small profits. If you only have a small amount of time to trade each
day, then this strategy might be the right one for you. Everyone will settle into
their own style of trading. This technique is for traders who like getting in and out
of trades in a matter of minutes instead of hours. Stock Index Futures traders
often use the 1minute charts to enter and exit trades. Forex day traders can also
gain an advantage by getting in on a move right as it happens by watching the 1
minute charts.
The type of chart set up that we use to trade the 1 minute charts is candlestick
charts. A great description of candlestick charts can be read about here:
http://rightline.iqchart.com/partner/rightline/education/candle_intro.asp
SET UP YOUR CHARTS
1. Open a new EUR/USD 1 minute candlestick chart.
2. Add Bollinger Bands set at 18, Exponential. Change the color of the middle
band to bright green.
3. Add a moving average 3 Exponential, Close and change the color to black.
4. Add the MACD Histogram Study (default settings)
5. Add the Relative Strength Index Study set at 14.
6. Zoom in or out to your liking.
This is what your chart and studies should look like: (See Next Page)
38
The Key to catching the “Micro Trends” on the 1 minute charts:
• Wait for the 3 EMA (black) to cross through the 18 Bollinger Bands Middle
line (green).
• Wait for the Relative Strength Index and MACD Histogram to line up:
Above 0 (MACD) and above 50 (RSI) for BUY signal. Below 0 (MACD) and
below 50 (RSI) for SELL signal.
• Remember to take small profits.
• Practice this strategy on your demo account.
*Examples starting on next page
39
This example is on a Late Sunday Night/Early Monday Morning EST EUR/USD
chart. A good BUY signal at this time could have been when the 3 EMA crossed
up through the Middle Bollinger Band, the MACD Histogram is above zero and
the RSI crossed above 50.
More examples on next page...
40
Here is both a BUY and SELL example from the Japanese trading session.
Notice how the RSI and MACD line up in both examples.
More examples on next page...
41
Here is an afternoon trading example of a BUY and SELL opportunity with the
EUR/USD pair. Remember to take small profits and/or move your stops in a
winning trade.
More examples on next page...
42
TRADE THE NEWS
Here is a great example of how you can use the 1 minute charts to trade the
economic news releases. To find out when the world economic news releases
are, simply go to http://www.forexnews.com and scroll down to the bottom of the
website for the list of the current week news releases that impact the Forex
markets. In the above example, the economic news release was scheduled for
8:30 AM EST. At 8:33 the price jumped up 20 pips. Using our 1 minute
strategy along with the news, is an effective way of scalping profits on the FX
markets.
**Tip: Remember to wait a minute or two after the announcement. Don't open a
position before the scheduled time!
**Tip: There are news releases all throughout the week during the different time
zones and trading sessions. This technique works well during overnight trading
EST during the European and London sessions.
More examples on next page...
43
Notice with this news release, that the EUR/USD pair dropped over 30 pips in 1
minute! At 8:32 the price dropped. If you can practice timing these trades they
can become a very profitable tool for the trader.
ATTENTION:
Using the 1 minute charts is fast moving. It might not be your style of trading. If
you want to test out slower moving average combinations that whipsaw less
often on the 1 minute charts, you can try these:
1. 7 EMA, 18 Middle Bollinger Band
2. 5 EMA, 20 Middle Bollinger Band
3. 10 EMA, 20 Middle Bollinger Band
44

The Day Trade Forex System [Erol Bortucene and Cynthia Macy]

2007-08-25T18:06:00.001-07:00

STUDY BOOK FOR SUCCESSFUL FOREIGN EXCHANGE

2007-08-25T17:58:00.002-07:00

ROYALFOREX
FOREX
STUDY BOOK FOR SUCCESSFUL FOREIGN EXCHANGE
DEALING
Los Angeles, California
2001
 2001 by Royal Forex. All right reserved. www.royalforex.com
2
Contents
1.Common knowledge about the trading on Forex
1.1. Forex as a aart af the global financial market
Brief data about the Forex rise and development.
The factors caused Foreign Exchange Volume Growth on Forex (Exchange Rate Volatility,
Business Internationalization, Increasing of Traders’ Sophistication, Developments in
Telecommunications, Computer And Programming Development).
The role of the U.S. Federal Reserve System and central banks of other G-7 countries on
Forex.
1.2. Risks by the trading on Forex
1.3. Forex sectors
Spot Market
Forward Market
Futures Market
Currency Options
2. Major currencies and trade systems
2.1. Major currencies
The U.S. Dollar
The Euro
The Japanese Yen
The British Pound
The Swiss Franc
2.2. Trade systems on Forex
Trading with brokers
Direct dealing
3. Fundamental analysis by trading on Forex
3.1 Theories of exchange rate determination
Purchasing Power Parity
Theory of Elasticities
Modern monetary theories on exchange rate volatility
3.2. Indicators for the fundamental analysis
Economic indicators
The Gross National Product
The Gross Domestic Product
Consumption Spending
Investment Spending
Government Spending
Net Trading
Industrial sector indicators
 2001 by Royal Forex. All right reserved. www.royalforex.com
3
Industrial Production
Capacity Utilization
Factory Orders
Durable Goods Orders
Business Inventories
Construction Data
Inflation Indicators
Producer Price Index
Consumer Price Index
Gross National Product Implicit Deflator
Gross Domestic Product Implicit Deflator
Commodity Research Bureau’s Futures Index
The Journal of Commerce Industrial Price
Balance of Payments
Merchandise Trade Balance
The U.S. – Japan Merchandise Trade Balance
Employment Indicators
Employment Cost Index
Consumer Spending Indicators
Retail Sales
Consumer Sentiment
Auto Sales
Leading Indicators
Personal Income
3.3. Forex dependence on financial and sociopolitical factors
The Role of Financial Factors
Political Crises Influence
4. Technical analysis
4.1. The destination and fundamentals of technical analysis
Theory of Dow
Percent measures of prices reverse
4.2. Charts for the technical analysis
Kinds of prices and time units
Kinds of charts
Line Chart
Bar Chart
Candlestick Chart
4.3. Trends, Support and Resistance lines
Trend Line and Trade Channel
Lines of Support and Resistance
4.4. Trend Reversal patterns
 2001 by Royal Forex. All right reserved. www.royalforex.com
4
Head-and-Shoulders
Inverted Head-and-Shoulders
Double Top
Double Bottom
Triple Top
Triple Bottom
Round Top, Round Bottom, Saucer, Inverted Saucer
4.5. Trend Continuation patterns
Flags
Pennants
Triangles
Wedges
Rectangles
4.6. Gaps
Common Gaps
Breakaway Gaps
Runaway Gaps
Exhaustion Gaps
4.7. Mathematical trading methods ( Technical indicators)
Moving Averages
Envelops
Ballinger Bands
Average True Range
Median Price
Oscillators
Commodity Channel Index
Directional Movement Index
Stochastics
Moving Average Convergence-Divergence (MACD)
Momentum
The Relative Strength Index (RSI)
Rate of Change (ROC)
Larry Williams’s %R
Indicators combination
Ichimoku Indicator
5. Fibonacci constants and Elliott waves theory
5.1. Fibonacci constants
5.2. Elliott wave theory
References
 2001 by Royal Forex. All right reserved. www.royalforex.com
5
1. Common knowledge about the trading on Forex
1.1. Foreign exchange as a part of the world financial market
Forex – What is it? The international currency market Forex is a special kind of the world financial
market. Trader’s purpose on the Forex to get profit as the result of foreign currencies purchase and sale. The
exchange rates of all currencies being in the market turnover are permanently changing under the action of the
demand and supply alteration. The latter is a strong subject to the influence of any important for the human
society event in the sphere of economy, politics and nature. Consequently current prices of foreign currencies
evaluated for instance in the US dollars fluctuate towards its higher and lower meanings. Using these
fluctuations in accordance with a known principle “buy cheaper – sell higher” traders obtain gains. Forex is
different in compare to all other sectors of the world financial system thanks to his heightened sensibility to
a large and continuously changing number of factors, accessibility to all individual and corporative traders,
exclusively high trade turnover which creates an ensured liquidity of traded currencies and the round - the
clock business hours which enable traders to deal after normal hours or during national holidays in
their country finding markets abroad open.
Just as on any other market the trading on Forex, along with an exclusively high potential profitability,
is essentially risk - bearing one. It is possible to gain a success on it only after a certain training including a
familiarization with the structure and kinds of Forex, the principles of currencies price formation, the factors
affecting prices alterations and trading risks levels, sources of the information necessary to account all those
factors, techniques of the analysis and prediction of the market movements as well as with the trading tools
and rules. An important role in the process of the preparation for the trading on Forex belongs to the demotrading
(that is to trade using a demo-account with some virtual money), which allows to testify all the
theoretical knowledge and to obtain a required minimum of the trade experience not being subjected to a
material damage.
Short data about the origin and development of the currency exchange market. Currency trading
has a long history and can be traced back to the ancient Middle East and Middle Ages when foreign
exchange started to take shape after the international merchant bankers devised bills of exchange, which
were transferable third-party payments that allowed flexibility and growth in foreign exchange dealings.
The modern foreign exchange market characterized by periods of high volatility (that is a frequency
and an amplitude of a price alteration) and relative stability formed itself in the twentieth century. By the
mid-1930s the British capital London became to be the leading center for foreign exchange and the British
pound served as the currency to trade and to keep as a reserve currency. Because in the old times foreign
exchange was traded on the telex machines, or cable, the pound has generally the nickname “cable”. After the
World War II, where the British economy was destroyed and the United States was the only country unscarred by
war, U.S. dollar, in accordance with the Breton Woods Accord between the USA, Great Britain and France
(1944) became the reserve currency for all the capitalist countries and all currencies were pegged to the
American dollar (through the constitution of currencies ranges maintained by central banks of relevant
countries by means of the interventions or currency purchases). In turn, the U.S. dollar was pegged to gold
at $35 per ounce. Thus, the U.S. dollar became the world's reserve currency. In accordance with the same
agreement was organized the International Monetary Fund (IMF) rendering now a significant financial
support to the developing and former socialist countries effecting economical transformation. To execute
these goals the IMF uses such instruments as Reserve trenches, which allows a member to draw on its own
reserve asset quota at the time of payment, Credit trenches drawings and stand-by arrangements. The
letters are the standard form of IMF loans unlike of those as the compensatory financing facility extends
 2001 by Royal Forex. All right reserved. www.royalforex.com
6
financial help to countries with temporary problems generated by reductions in export revenues, the buffer
stock financing facility which is geared toward assisting the stocking up on primary commodities in order
to ensure price stability in a specific commodity and the extended facility designed to assist members with
financial problems in amounts or for periods exceeding the scope of the other facilities.
At the end of the 70-s the free-floating of currencies was officially mandated that became the
most important landmark in the history of financial markets in the XX century lead to the formation
of Forex in the contemporary understanding. That is the currency may be traded by anybody and its value
is a function of the current supply and demand forces in the market, and there are no specific
intervention points that have to be observed. Foreign exchange has experienced spectacular growth in
volume ever since currencies were allowed to float freely against each other. While the daily turnover in
1977 was U.S. $5 billion, it increased to U.S. $600 billion in 1987, reached the U.S. $1 trillion mark in
September 1992, and stabilized at around $1.5 trillion by the year 2000. Main factors influences on this
spectacular growth in volume are mentioned below. A significant role belonged to the increased volatility of
currencies rates, growing mutual influence of different economies on bank-rates established by central banks,
which affect essentially currencies exchange rates, more intense competition on goods markets and, at the same
time, amalgamation of the corporations of different countries, technological revolution in the sphere of the
currencies trading. The latter exposed in the development of automated dealing systems and the transition to
the currency trading by means of the Internet. In addition to the dealing systems, matching systems
simultaneously connect all traders around the world, electronically duplicating the brokers' market.
Advances in technology, computer software, and telecommunications and increased experience have
increased the level of traders' sophistication, their ability to both generate profits and properly handle the
exchange risks. Therefore, trading sophistication led toward volume increase.
Regional reserve countries. Along with the global reserve currency – U.S. dollar, there are also
other regional and international reserve countries.
In 1978, the nine members of the European Community ratified a plan for the creation of the
European Monetary System managed by the European Fund of the Monetary Cooperation. By 1999
these countries, which constituted so-called Euro zone, have implemented the transition to the common
European currency - the euro (see Figure 1.1).
The euro bills are issued in denominations of 5, 10, 20, 50, 100, 200, and 500 euros. Coins are issued
in denominations of 1 and 2 euros, and 50, 20,10, 5, 2, and 1 cent.
 2001 by Royal Forex. All right reserved. www.royalforex.com
7
Figure 1.1. The Euro notes.
The euro is a regional reserve currency for the euro zone countries and the Japanese yen – for
the countries of South – East Asia. The portfolio of reserve currencies may change depending on
specific international conditions, to include the Swiss franc.
The role of U.S. Federal Reserve System and Central banks of other G-7 countries on
Forex. All central banks, and the U.S. Federal Reserve System (FRS) as well, affect the foreign
exchange markets changing discount rates and performing the monetary operations (as interventions and
currency purchases).
For the foreign exchange operations most significant are repurchase agreements to sell the same
security back at the same price at a predetermined date in the future (usually within 15 days), and at a
specific rate of interest. This arrangement amounts to a temporary injection of reserves into the banking
system. The impact on the foreign exchange market is that the national currency should weaken. The
repurchase agreements may be either customer repos or system repos.
Matched sale-purchase agreements are just the opposite of repurchase agreements. When
executing a matched sale-purchase agreement, a bank or the FRS sells a security for immediate delivery to a
dealer or a foreign central bank, with the agreement to buy back the same security at the same price at a
predetermined time in the future (generally within 7 days). This arrangement amounts to a temporary drain
of reserves. The impact on the foreign exchange market is that the national currency should strengthen.
Monetary operations include payments among central banks or to international agencies. In addition, the FRS has
entered a series of currency swap arrangements with other central banks since 1962. For instance, to help the
allied war effort against Iraq's invasion of Kuwait in 1990-1991, payments were executed by the Bundesbank and
Bank of Japan to the Federal Reserve. Also, payments to the World Bank or the United Nations are executed through
central banks.
 2001 by Royal Forex. All right reserved. www.royalforex.com
8
Intervention in the United States foreign exchange markets by the U.S. Treasury and the FRS is
geared toward restoring orderly conditions in the market or influencing the exchange rates. It is not
geared toward affecting the reserves.
There are two types of foreign exchange interventions: naked intervention and sterilized intervention.
Naked intervention, or unsterilized intervention, refers to the sole foreign exchange activity. All
that takes place is the intervention itself, in which the Federal Reserve either buys or sells U.S. dollars
against a foreign currency. In addition to the impact on the foreign exchange market, there is also a
monetary effect on the money supply. If the money supply is impacted, then consequent adjustments must
be made in interest rates, in prices, and at all levels of the economy. Therefore, a naked foreign exchange
intervention has a long-term effect.
Sterilized intervention neutralizes its impact on the money supply. As there are rather few central
banks that want the impact of their intervention in the foreign exchange markets to affect all corners of their
economy, sterilized interventions have been the tool of choice. This holds true for the FRS as well. The
sterilized intervention involves an additional step to the original currency transaction. This step consists of
a sale of government securities that offsets the reserve addition that occurs due to the intervention. It may
be easier to visualize it if you think that the central bank will finance the sale of a currency through the sale
of a number of government securities. Because a sterilized intervention only generates an impact on the supply
and demand of a certain currency, its impact will tend to have a short-to medium-term effect.
1.2. Risks by the foreign exchange on Forex
As it was mentioned above the trading on the Forex is essentially risk-bearing. By the evaluation of
the grade of a possible risk accounted should be the following kinds of it: exchange rate risk, interest rate
risk, and credit risk, country risk.
Exchange rate risk. Exchange rate risk is the effect of the continuous shift in the worldwide
market supply and demand balance on an outstanding foreign exchange position. For the period it is
outstanding, the position will be subject to all the price changes.
The most popular measures to cut losses short and ride profitable positions that losses should be kept
within manageable limits are the position limit and the loss limit. By the position limitation a maximum
amount of a certain currency a trader is allowed to carry at any single time during the regular trading hours is
to be established. The loss limit is a measure designed to avoid unsustainable losses made by traders by
means of stop-loss levels setting.
Interest rate risk. Interest rate risk refers to the profit and loss generated by fluctuations in the
forward spreads, along with forward amount mismatches and maturity gaps among transactions in the
foreign exchange book. This risk is pertinent to currency swaps, forward outright, futures, and options (See
below). To minimize interest rate risk, one sets limits on the total size of mismatches. A common approach
is to separate the mismatches, based on their maturity dates, into up to six months and past six months.
All the transactions are entered in computerized systems in order to calculate the positions for all the
dates of the delivery, gains and losses. Continuous analysis of the interest rate environment is necessary to
forecast any changes that may impact on the outstanding gaps.
Credit risk. Credit risk refers to the possibility that an outstanding currency position may not be
repaid as agreed, due to a voluntary or involuntary action by a counter party. In these cases, trading
occurs on regulated exchanges, such as the clearinghouse of Chicago. The following forms of credit risk
are known:
 2001 by Royal Forex. All right reserved. www.royalforex.com
9
1. Replacement risk occurs when counterparties of the failed bank find their books are subjected
to the danger not to get refunds from the bank, where appropriate accounts became unbalanced.
2. Settlement risk occurs because of the time zones on different continents. Consequently,
currencies may be traded at the different price at different times during the trading day. Australian and New
Zealand dollars are credited first, then Japanese yen, followed by the European currencies and ending with
the U.S. dollar. Therefore, payment may be made to a party that will declare insolvency (or be declared
insolvent) immediately after, but prior to executing its own payments.
Therefore in assessing the credit risk, end users must consider not only the market value of their
currency portfolios, but also the potential exposure of these portfolios. The potential exposure may be
determined through probability analysis over the time to maturity of the outstanding position. The
computerized systems currently available are very useful in implementing credit risk policies. Credit lines
are easily monitored. In addition, the matching systems introduced in foreign exchange since April 1993 are
used by traders for credit policy implementation as well. Traders input the total line of credit for a specific
counterparty. During the trading session, the line of credit is automatically adjusted. If the line is fully used,
the system will prevent the trader from further dealing with that counterparty. After maturity, the credit
line reverts to its original level.
Dictatorship risk. Dictatorship (sovereign) risk refers to the government's interference in the Forex
activity. Although theoretically present in all foreign exchange instruments, currency futures are, for all
practical purposes, excepted from country risk, because the major currency futures markets are located in
the USA. Hence, traders have to realize that kind of the risk and be in state to account possible
administrative restrictions.
1.3. Kinds of the Forex
Spot Market. Currency spot trading is the most popular foreign currency instrument around the
world, making up 37 percent of the total activity (See Figure 3.1). The features of the fast-paced spot
market are high volatility and quick profits (as well losses).
WDS* SWAPS
Figure 1.2. Market share of US spot trading (in %% of the volume): 1 – forwards and swaps; 2 – options; 3 - futures; 4 –
spots.
A spot deal consists of a bilateral contract whereby a party delivers a specified amount of a given
currency against receipt of a specified amount of another currency from a counterparty, based on an agreed
57%
5%
1%
37%
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exchange rate, within two business days of the deal date. The exception is the Canadian dollar, in which
the spot delivery is executed next business day. The two-day spot delivery for currencies was developed
long before technological breakthroughs in information processing. This time period was necessary to
check out all transactions' details among counterparties. Although technologically feasible, the
contemporary markets did not find it necessary to reduce the time to make payments. Human errors still
occur and they need to be fixed before delivery.
By the entering into a contract on the spot market a bank serving a trader tells the latter the
quota – an evaluation of the currency traded against the U.S. dollar or an other currency. A quota
consists from two figures (for example, USD/JPY = 133.27/133.32 or, which is the same, USD/JPY
= 133.27/32). The first from these figures (the left part) is called the bid – price (that is a price at
which the trader sells), the second (the right part) is called the ask - price (the price at which the
trader buys the currency). The difference between asks and bid is called the spread. The spread, as
any currency price alteration, is being measured in points (pips).
In terms of volume, currencies around the world are traded mostly against the U.S. dollar, because
the U.S. dollar is the currency of reference. The other major currencies are the euro, followed by the
Japanese yen, the British pound, and the Swiss franc. Other currencies with significant spot market shares
are the Canadian dollar and the Australian dollar. In addition, a significant share of trading takes place in the
currencies crosses, a non-dollar instrument whereby foreign currencies are quoted against other foreign
currencies, such as euro against Japanese yen.
The spot market is characterized by high liquidity and high volatility. Volatility is the degree to
which the price of currency tends to fluctuate within a certain period of time. For instance, in an active
global trading day (24 hours), the euro/dollar exchange rate may change its value 18,000 times "flying"
100-200 pips in a matter of seconds if the market gets wind of a significant event. On the other hand, the
exchange rate may remain quite static for extended periods of time, even in excess of an hour, when one
market is almost finished trading and waiting for the next market to take over. For example, there is a
technical trading gap between around 4:30 PM and 6 PM EDT. In the New York market, the majority of
transactions occur between 8 AM and 12 PM, when the New York and European markets overlap. The
activity drops sharply in the afternoon, over 50 percent in fact, when New York loses the international
trading support. (See Figure 1.3) Overnight trading is limited, as very few banks have overnight desks.
Most of the banks send their overnight orders to branches or other banks that operate in the active time
zones.
The reasons of the spot-market popularity, in addition to the fast liquidity-taking place thanks to the
volatility, belongs also the short time of a contract execution. Therefore the credit risk is on that market
restricted. The profit and loss can be either realized or unrealized. The realized P&L is a certain amount of
money netted when a position is closed. The unrealized P&L consists of an uncertain amount of money that an
outstanding position would roughly generate if it were closed at the current rate. The unrealized P&L changes
continuously in tandem with the exchange rate.
Forward Market. On the forward Forex are used two tools: forward outright deals and exchange
deals or swaps. A swap deal is a combination of a spot deal and a forward outright deal.
According to figures published by the Bank for the International Settlements, the percentage share
of the forward market was 57 percent in 1998. (See Figure 1.2). Translated into U.S. dollars, out of an
estimated daily gross turnover of US$1.49 trillion, the total forward market represents US$900 billion. In
the forward market there is no norm with regard to the settlement dates, which range from 3 days to 3
years. Volume in currency swaps longer than one year tends to be light but, technically, there is no
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Figure 1.3. Diagram of the trade activity (in %% of the volume) of US Forex in time distribution: 1 – from 12 pm till 4 pm, 2
– from 4 pm till 8 pm, 3 – from 8 am till 12 pm.
impediment to making these deals. Any date past the spot date and within the above range may be a
forward settlement, provided that it is a valid business day for both currencies. The forward markets are
decentralized markets, with players around the world entering into a variety of deals either on a one-onone
basis or through brokers.
The forward price consists of two significant parts: the spot exchange rate and the forward spread.
The spot rate is the main building block. The forward spread is also known as the forward points or the
forward pips. The forward spread is necessary for adjusting the spot rate for specific settlement dates
different from the spot date. It holds, then, that the maturity date is another determining factor of the
forward price.
Futures Market. Currency futures are specific types of forward outright deals. Because
they are derived from the spot price, they are derivative instruments. (See Figure 1.2). They are specific
with regard to the expiration date and the size of the trade amount. Whereas, generally, forward outright
deals—those that mature past the spot delivery date—will mature on any valid date in the two countries
whose currencies are being traded, standardized amounts of foreign currency futures mature only on the
third Wednesday of March, June, September, and December.
The following characteristics of currency futures that make them attractive. They are open to all
market participants, individuals included. It is a central market, just as efficient as the cash market,
and whereas the cash market is a very decentralized market, futures trading takes place under one roof. It
eliminates the credit risk because the Chicago Mercantile Exchange Clearinghouse acts as the buyer
for every seller, and vice versa. In turn, the Clearinghouse minimizes its own exposure by requiring traders
who maintain a nonprofitable position to post margins equal in size to their losses. Although the futures and
spot markets trade closely together, certain divergences between the two occur, generating arbitraging
opportunities. Gaps, volume, and open interest are significant technical analysis tools (See Chapter 4)
solely available in the futures market.
Because of these benefits, currency futures trading volume has steadily attracted a large variety
of players.
Because futures are forward outright contracts and the forward prices are generally slow movers, the
elimination of the forward spreads will transform the futures contracts into spot contracts.
For traders outside the exchange, the prices are available from on-line monitors. The most popular
pages are found on Bridge, Telerate, Reuters, and Bloomberg. Telerate presents the currency futures on
29%
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composite pages, while Reuters and Bloomberg display currency futures on individual pages shows the
convergence between the futures and spot prices.
Options Market. A currency option is a contract between a buyer and a seller that gives the
buyer the right, but not the obligation, to trade a specific amount of currency at a predetermined price and
within a predetermined period of time, regardless of the market price of the currency; and gives the
seller, or writer, the obligation to deliver the currency under the predetermined terms, if and when the
buyer wants to exercise the option.
More factors affect the option price relative to the prices of other foreign currency instruments. Unlike
spot or forwards, both high and low volatility may generate a profit in the options market. For some, options are a
cheaper vehicle for currency trading. For others, options mean added security and exact stop-loss order execution.
Currency options constitute the fastest-growing segment of the foreign exchange market. As of April 1998,
options represented 5 percent of the foreign exchange market. (See Figure 1.4). The biggest options trading center
is the United States, followed by the United Kingdom and Japan. Options prices are based on, or derived
from, the cash instruments. Often, however, traders have misconceptions regarding both the difficulty and
simplicity of using options. There are also misconceptions regarding the capabilities of options.
Trading an option on currency futures will entitle the buyer to the right, but not the obligation,
to take physical possession of the currency future. Unlike the currency futures, buying currency
options does not require an initiation margin. The option premium, or price, paid by the buyer to the
seller, or writer, reflects the buyer's total risk.
However, upon taking physical possession of the currency future by exercising the option, a trader
will have to deposit a margin.
Figure 1.4. Market share of the currency options (in %% of the volume): 1 - OTC; 2 – organized exchanges.
The currency price is the central building block, as all the other factors are compared and analyzed
against it. It is the currency price behavior that both generate the need for options and impacts on the profitability of
options.
2. Kinds of major currencies and exchange systems
2.1. Major currencies
The U.S. Dollar. The United States dollar is the world's main currency – an universal measure
to evaluate any other currency traded on Forex. All currencies are generally quoted in U.S. dollar terms.
Under conditions of international economic and political unrest, the U.S. dollar is the main safe-haven
currency, which was proven particularly well during the Southeast Asian crisis of 1997-1998.
81%
19%
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As it was indicated, the U.S. dollar became the leading currency toward the end of the Second
World War along the Breton Woods Accord, as the other currencies were virtually pegged against it. The
introduction of the euro in 1999 reduced the dollar's importance only marginally.
The other major currencies traded against the U.S. dollar are the euro, Japanese yen, British
pound, and Swiss franc.
The Euro. The euro was designed to become the premier currency in trading by simply being
quoted in American terms. Like the U.S. dollar, the euro has a strong international presence
stemming from members of the European Monetary Union. The currency remains plagued by unequal
growth, high unemployment, and government resistance to structural changes. The pair was also weighed
in 1999 and 2000 by outflows from foreign investors, particularly Japanese, who were forced to liquidate
their losing investments in euro-denominated assets. Moreover, European money managers rebalanced
their portfolios and reduced their euro exposure as their needs for hedging currency risk in Europe
declined.
The Japanese Yen. The Japanese yen is the third most traded currency in the world; it has a
much smaller international presence than the U.S. dollar or the euro. The yen is very liquid around the
world, practically around the clock. The natural demand to trade the yen concentrated mostly among the
Japanese keiretsu, the economic and financial conglomerates. The yen is much more sensitive to the
fortunes of the Nikkei index, the Japanese stock market, and the real estate market.
The British Pound. Until the end of World War II, the pound was the currency of reference.
The currency is heavily traded against the euro and the U.S. dollar, but has a spotty presence against other
currencies. Prior to the introduction of the euro, both the pound benefited from any doubts about the
currency convergence. After the introduction of the euro, Bank of England is attempting to bring the high
U.K. rates closer to the lower rates in the euro zone. The pound could join the euro in the early 2000s,
provided that the U.K. referendum is positive.
The Swiss Franc. The Swiss franc is the only currency of a major European country that
belongs neither to the European Monetary Union nor to the G-7 countries. Although the Swiss economy
is relatively small, the Swiss franc is one of the four major currencies, closely resembling the strength
and quality of the Swiss economy and finance. Switzerland has a very close economic relationship with
Germany, and thus to the euro zone. Therefore, in terms of political uncertainty in the East, the Swiss
franc is favored generally over the euro.
Typically, it is believed that the Swiss franc is a stable currency. Actually, from a foreign
exchange point of view, the Swiss franc closely resembles the patterns of the euro, but lacks its liquidity.
As the demand for it exceeds supply, the Swiss franc can be more volatile than the euro.
2.2. Trade systems on Forex
Trading with brokers. Foreign exchange brokers, unlike equity brokers, do not take positions for
themselves; they only service banks. Their roles are to bring together buyers and sellers in the market, to
optimize the price they show to their customers and quickly, accurately, and faithfully executing the
traders' orders.
The majority of the foreign exchange brokers execute business via phone using an open box system
— a microphone in front of the broker that continuously transmits everything he or she says on the direct
phone lines to the speaker boxes in the banks. This way, all banks can hear all the deals being executed.
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Because of the open box system used by brokers, a trader is able to hear all prices quoted; whether the bid
was hit or the offer taken; and the following price. What the trader will not be able to hear is the amounts
of particular bids and offers and the names of the banks showing the prices. Prices are anonymous. The
anonymity of the banks that are trading in the market ensures the market's efficiency, as all banks have a fair
chance to trade.
Sometimes brokers charge a commission that is paid equally by the buyer and the seller. The fees
are negotiated on an individual basis by the bank and the brokerage firm.
Brokers show their customers the prices made by other customers either two-way (bid and offer)
prices or one way (bid or offer) prices from his or her customers. Traders show different prices because they
"read" the market differently; they have different expectations and different interests. A broker who has
more than one price on one or both sides will automatically optimize the price. In other words, the broker
will always show the highest bid and the lowest offer. Therefore, the market has access to an optimal
spread possible. Fundamental and technical analyses are used for forecasting the future direction of the
currency. A trader might test the market by hitting a bid for a small amount to see if there is any reaction.
Another advantage of the brokers' market is that brokers might provide a broader selection of banks to
their customers. Some European and Asian banks have overnight desks so their orders are usually placed
with brokers who can deal with the American banks, adding to the liquidity of the market.
Direct dealing. Direct dealing is based on trading reciprocity. A market maker—the bank
making or quoting a price — expects the bank that is calling to reciprocate with respect to making a price
when called upon. Direct dealing provides more trading discretion, as compared to dealing in the brokers'
market. Sometimes traders take advantage of this characteristic.
Direct dealing used to be conducted mostly on the phone. Phone dealing was error-prone and slow.
Dealing errors were difficult to prove and even more difficult to settle. Direct dealing was forever changed
in the mid-1980s, by the introduction of dealing systems.
Dealing systems are on-line computers that link the contributing banks around the world on a
one-on-one basis. The performance of dealing systems is characterized by speed, reliability, and safety.
Dealing systems are continuously being improved in order to offer maximum support to the dealer's main
function: trading. The software is rather reliable in picking up the big figure of the exchange rates and the
standard value dates. In addition, it is extremely precise and fast in contacting other parties, switching
among conversations, and accessing the database. The trader is in continuous visual contact with the
information exchanged on the monitor. It is easier to see than hear this information, especially when
switching among conversations.
Most banks use a combination of brokers and direct dealing systems. Both approaches reach the
same banks, but not the same parties, because corporations, for instance, cannot deal in the brokers'
market. Traders develop personal relationships with both brokers and traders in the markets, but select their
trading medium based on price quality, not on personal feelings. The market share between dealing systems
and brokers fluctuates based on market conditions. Fast market conditions are beneficial to dealing systems,
whereas regular market conditions are more beneficial to brokers.
Matching systems. Unlike dealing systems, on which trading is not anonymous and is conducted
on a one-on-one basis, matching systems are anonymous and individual traders deal against the rest of the
market, similar to dealing in the brokers' market. However, unlike the brokers' market, there are no
individuals to bring the prices to the market, and liquidity may be limited at times. Matching systems are
well-suited for trading smaller amounts as well.
The dealing systems' characteristics of speed, reliability, and safety are replicated in the
matching systems. In addition, credit lines are automatically managed by the systems. Traders input the
total credit line for each counterparty. When the credit line has been reached, the system automatically
 2001 by Royal Forex. All right reserved. www.royalforex.com
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disallows dealing with the particular party by displaying credit restrictions, or shows the trader only
the price made by banks that have open lines of credit. As soon as the credit line is restored, the system
allows the bank to deal again. In the inter-bank market, traders deal directly with dealing systems,
matching systems, and brokers in a complementary fashion.
3. Fundamental analysis by trading on Forex
Two types of analysis are used for the market movements forecasting: fundamental, and technical
(the chart study of past behavior of currencies prices). The fundamental one focuses on the theoretical
models of exchange rate determination and on the major economic factors and their likelihood of affecting
the foreign exchange rates.
3.1. Theories of exchange rate determination
Purchasing power parity. Purchasing power parity states that the price of a good in one
country should equal the price of the same good in another country, exchanged at the current rate—the
law of one price. There are two versions of the purchasing power parity theory: the absolute version and the
relative version. Under the absolute version, the exchange rate simply equals the ratio of the two countries'
general price levels, which is the weighted average of all goods produced in a country. However, this
version works only if it is possible to find two countries, which produce or consume the same goods.
Moreover, the absolute version assumes that transportation costs and trade barriers are insignificant. In
reality, transportation costs are significant and dissimilar around the world. Trade barriers are still alive and
well, sometimes obvious and sometimes hidden, and they influence costs and goods distribution.
Finally, this version disregards the importance of brand names. For example, cars are chosen not
only based on the best price for the same type of car, but also on the basis of the name ("You are what you
drive").
Under the PPP relative version, the percentage change in the exchange rate from a given base
period must equal the difference between the percentage change in the domestic price level and the
percentage change in the foreign price level. The relative version of the PPP is also not free of problems: it
is difficult or arbitrary to define the base period, trade restrictions remain a real and thorny issue, just as
with the absolute version, different price index weighting and the inclusion of different products in the
indexes make the comparison difficult and in the long term, countries' internal price ratios may change,
causing the exchange rate to move away from the relative PPP.
In conclusion, the spot exchange rate moves independently of relative domestic and foreign prices.
In the short run, the exchange rate is influenced by financial and not by commodity market conditions.
Theory of elasticities. The theory of elasticities holds that the exchange rate is simply the price
of foreign exchange that maintains the balance of payments in equilibrium. In other words, the degree to
which the exchange rate responds to a change in the trade balance depends entirely on the elasticity of
demand to a change in price. For instance, if the imports of country A are strong, then the trade balance
is weak. Consequently, the exchange rate rises, leading to the growth of country A's exports, and triggers
in turn a rise in its domestic income, along with a decrease in its foreign income. Whereas a rise in the
domestic income (in country A) will trigger an increase in the domestic consumption of both domestic and
foreign goods and, therefore, more demand for foreign currencies, a decrease in the foreign income (in
country B) will trigger a decrease in the domestic consumption of both country B's domestic and foreign
goods, and therefore less demand for its own currency.
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The elasticities approach is not problem-free because in the short term the exchange rate is more
inelastic than it is in the long term and additional exchange rate variables arise continuously, changing the
rules of the game.
Modern monetary theories on short-term exchange rate volatility. The modern monetary
theories on short-term exchange rate volatility take into consideration the short-term capital markets'
role and the long-term impact of the commodity markets on foreign exchange. These theories hold that the
divergence between the exchange rate and the purchasing power parity is due to the supply and demand
for financial assets and the international capability.
One of the modern monetary theories states that exchange rate volatility is triggered by a onetime
domestic money supply increase, because this is assumed to raise expectations of higher future
monetary growth.
The purchasing power parity theory is extended to include the capital markets. If, in both countries
whose currencies are exchanged, the demand for money is determined by the level of domestic income and
domestic interest rates, then a higher income increases demand for transactions balances while a higher
interest rate increases the opportunity cost of holding money, reducing the demand for money.
Under a second approach, the exchange rate adjusts instantaneously to maintain continuous interest
rate parity, but only in the long run to maintain PPP. Volatility occurs because the commodity markets adjust
more slowly than the financial markets. This version is known as the dynamic monetary approach.
Synthesis of traditional and modern monetary views. In order to better suit the previous
theories to the realities of the market, some of the more stringent conditions were adjusted into a synthesis
of the traditional and modern monetary theories.
A short-term capital outflow induced by a monetary shock creates a payments imbalance that
requires an exchange rate change to maintain balance of payments equilibrium. Speculative forces,
commodity markets disturbances, and the existences of short-term capital mobility trigger the exchange rate
volatility. The degree of change in the exchange rate is a function of consumers' elasticity of demand.
Because the financial markets adjust faster than the commodities markets, the exchange rate tends to be
affected in the short term by capital market changes, and in the long term by commodities changes.
3.2. Economic for the fundamental analysis
For the fundamental analysis on Forex, just as on any goods market, traders use the
information from analytical reviews of specialists published in newspapers as well as charts and
tables of many numerical indicators serving this purpose. All fundamental indicators generally.
released on a monthly basis, except of the Gross Domestic Product and the Employment Cost Index, which
are released quarterly (See below).
All economic indicators are released in pairs. The first number reflects the latest period. The
second number is the revised figure for the month prior to the latest period. For instance, in July, economic
data is released for the month of June, the latest period. In addition, the release includes the revision of
the same economic indicator figure for the month of May. The reason for the revision is that the
department in charge of the economic statistics compilation is in a better position to gather more information
in a month's time. This feature is important for traders. If the figure for an economic indicator is better than
expected by 0.4% for the past month, but the previous month's number is revised lower by 0.4%, then
traders can draw a justified conclusion about the economy situation.
Economic indicators are released at different times. In the United States, economic data is
generally released at 8:30 and 10 AM ET. It is important to remember that the most significant data for
foreign exchange is released at 8:30 AM ET. In order to allow time for last-minute adjustments, the United
States currency futures markets open at 8:20 AM ET.
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Sources of information. Information on upcoming economic indicators is published in all
leading newspapers, such as the Wall Street Journal, the Financial Times, and the New York Times; and
business magazines, such as Business Week. More often than not, traders use the monitor sources—
Bridge Information Systems, Reuters, or Bloomberg — to gather information both from news
publications and from the sources' own up-to-date information.
Separate groups of fundamental indicators are considered below in accordance with a
generally accepted classification.
Economic indicators
The Gross National Product (GNP). The Gross National Product measures the economic
performance of the whole economy. This indicator consists, at macro scale, of the sum of consumption
spending, investment spending, government spending, and net trade. The gross national product refers to the
sum of all goods and services produced by United States residents, either in the United States or abroad.
The Gross Domestic Product (GDP). The Gross Domestic Product refers to the sum of all goods
and services produced in the United States, either by domestic or foreign companies. The differences
between the two are nominal in the case of the economy of the United States. GDP figures are more
popular outside the United States. In order to make it easier to compare the performances of different
economies, the United States also releases GDP figures.
Consumption Spending. Consumption is made possible by personal income and discretionary
income. The decision by consumers to spend or to save is psychological in nature. Consumer
confidence is also measured as an important indicator of the propensity of consumers who have discretionary
income to switch from saving to buying.
Investment Spending. Investment — or gross private domestic spending — consists of fixed
investment and inventories.
Government Spending. Government spending is very influential in terms of both sheer size and its
impact on other economic indicators, due to special expenditures. For instance, United States military
expenditures had a significant role in total U.S. employment until 1990. The defense cuts that occurred at
the time increased unemployment figures in the short run.
Net Trade. Net trade is another major component of the GNP. Worldwide internationalization and
the economic and political developments since 1980 have had a sharp impact on the United States' ability to
compete overseas. The U.S. trade deficit of the past decades has slowed down the overall GNP. GNP
can be approached in two ways: flow of product and flow of cost.
Industrial sector indicators
Industrial Production indicator consists of the total output of a nation's plants, utilities, and
mines. From a fundamental point of view, it is an important economic indicator that reflects the strength of
the economy, and by extrapolation, the strength of a specific currency. Therefore, foreign exchange traders
use this economic indicator as a potential trading signal.
Capacity utilization indicator consists of total industrial output divided by total production
capability. The term refers to the maximum level of output a plant can generate under normal business
conditions. In general, capacity utilization is not a major economic indicator for the foreign exchange
market. However, there are instances when its economic implications are useful for fundamental analysis.
A "normal" figure for a steady economy is 81.5 percent. If the figure reads 85 percent or more, the
data suggests that the industrial production is overheating, that the economy is close to full capacity.
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High capacity utilization rates precede inflation, and expectation in the foreign exchange market is
that the central bank will raise interest rates in order to avoid or fight inflation.
Factory orders. Refer to the total of durable and nondurable goods orders. Nondurable goods
consist of food, clothing, light industrial products, and products designed for the maintenance of durable
goods. Durable goods orders are discussed separately. The factory orders indicator has limited significance
for foreign exchange traders.
Durable goods orders. Consist of products with a life span of more than three years. Examples of
durable goods are autos, appliances, furniture, jewelry, and toys. They are divided into four major
categories: primary metals, machinery, electrical machinery, and transportation.
In order to eliminate the volatility pertinent to large military orders, the indicator includes a
breakdown of the orders between defense and non-defense.
This data is fairly important to foreign exchange markets because it gives a good indication of
consumer confidence. Because durable goods cost more than nondurables, a high number in this
indicator shows consumers' propensity to spend. Therefore, a good figure is generally bullish for the
domestic currency.
Business inventories. Consist of items produced and held for future sale. The compilation of this
information is facile and holds little surprise for the market. Moreover, financial management and
computerization help control business inventories in unprecedented ways. Therefore, the importance of this
indicator for foreign exchange traders is limited.
Construction Data
Construction indicator constitutes significant group that are included in the calculation of the GDP
of the United States. Moreover, housing has traditionally been the engine that pulled the U.S. economy out
of recessions after World War II. These indicators are classified into three major categories:
1. housing starts and permits
2. new and existing one-family home sales; and
3. construction spending.
Construction indicators are cyclical and very sensitive to the level of interest rates (and
consequently mortgage rates) and the level of disposable income. Low interest rates alone may not be able
to generate a high demand for housing, though. As the situation in the early 1990s demonstrated,
despite historically low mortgage rates in the United States, housing increased only marginally, as a result
of the lack of job security in a weak economy. Besides, in spite of the 2000 – 2001 recession the cost of houses,
for example in California, was practically not decreased.
Housing starts between one and a half and two million units reflect a strong economy, whereas a
figure of approximately one million units suggests that the economy is in recession.
Inflation indicators
Traders watch the development of inflation closely, because the method of choice for fighting
inflation is raising the interest rates, and higher interest rates tend to support the local currency. To
measure inflation traders use economic tools considered below.
Producer price index (PPI). It’s compiled from most sectors of the economy, such as
manufacturing, mining, and agriculture. The sample used to calculate the index contains about 3400
commodities. The weights used for the calculation of the index for some of the most important groups
 2001 by Royal Forex. All right reserved. www.royalforex.com
19
are: food—24 percent; fuel—7 percent; autos—7 percent; and clothing—6 percent. Unlike the CPI, the
PPI does not include imported goods, services, or taxes.
Consumer price index (CPI). Reflects the average change in retail prices for a fixed market
basket of goods and services. The CPI data is compiled from a sample of prices for food, shelter, clothing,
fuel, transportation, and medical services that people purchase on daily basis. The weights attached for
the calculation of the index to the most important groups are: housing—38 percent; food—19 percent;
fuel—8 percent; and autos—7 percent.
The two indexes, PPI and CPI, are instrumental in helping traders measure inflationary activity,
although the Federal Reserve takes the position that the indexes overstate the strength of inflation.
Gross national product implicit deflator. It’s calculated by dividing the current dollar GNP
figure by the constant dollar GNP figure.
Gross domestic product implicit deflator. It’s calculated by dividing the current dollar GDP
figure by the constant dollar GDP figure.
Both the GNP and GDP implicit deflators are released quarterly, along with the respective GNP
and GDP figures. The implicit deflators are generally regarded as the most significant measure of inflation.
Commodity research bureau's (CRB) futures index . The Commodity Research Bureau's
Futures Index makes watching for inflationary trends easier. The CRB Index consists of the equally
weighted futures prices of 21 commodities. The components of the CRB Index are:
• Precious metals: gold, silver and platinum
• Industrials: crude oil, heating oil, unleaded gas, lumber, copper, and cotton
• Grains: corn, wheat, soybeans, soy meal, soy oil
• Livestock and meat: cattle, hogs, and pork bellies
• Imports: coffee, cocoa, sugar
• Miscellaneous: orange juice
The preponderance of food commodities makes the CRB Index less reliable in terms of general
inflation. Nevertheless, the index is a popular tool that has proved quite reliable since the late 1980s.
The “Journal of Commerc” industrial price index (JoC). Consists of the prices of 18 industrial materials
and supplies processed in the initial stages of manufacturing, building, and energy production. It is more
sensitive than other indexes, as it was designed to signal changes in inflation prior to the other price indexes.
Merchandise trade balance
It’s one of the most important economic indicators. Its value may trigger long-lasting changes in
monetary and foreign policies. The trade balance consists of the net difference between the exports and
imports of a certain economy. The data includes six categories:
1. food,
2. raw materials and industrial supplies,
3. consumer goods,
4. autos,
5. Capital goods,
6. Other merchandise.
A separate indicator that belongs to that group is the “US – Japan Merchandise Trade
Balance”.
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Employment Indicators.
The employment rate is an economic indicator with significance in multiple areas. The rate of
employment, naturally, measures the soundness of an economy (See Figure 3.1). The unemployment rate
is a lagging economic indicator. It is an important feature to remember, especially in times of economic
recession. Whereas people focus on the health and recovery of the job sector, employment is the last
economic indicator to rebound. When economic contraction causes jobs to be cut, it takes time to generate
psychological confidence in economic recovery at the managerial level before new positions are added.
At individual levels, the improvement of the job outlook may be clouded when new positions are added in
small companies and thus not fully reflected in the data. The employment reports are significant to the
financial markets in general and to foreign exchange in particular. In foreign exchange, the data is truly
affective in periods of economic transition—recovery and contraction. The reason for the indicators'
importance in extreme economic situations lies in the picture they paint of the health of the economy
and in the degree of maturity of a business cycle. A decreasing unemployment figure signals a maturing
cycle, whereas the opposite is true for an increasing unemployment indicator.
Figure 3.1. Diagram of the U.S. unemployment rate.
Consumer spending indicators. Retail sales are a significant consumer-spending indicator for
foreign exchange traders, as it shows the strength of consumer demand as well as consumer confidence.
component in the calculation of other economic indicators, such as GNP and GDP.
Generally, the most commonly used employment figure is not the monthly unemployment rate,
which is released as a percentage, but the nonfarm payroll rate. The rate figure is calculated as the
ratio of the difference between the total labor force and the employed labor force, divided by the total
labor force. The data is more complex, though, and it generates more information. In Forex, the standard
indicators monitored by traders are the unemployment rate, manufacturing payrolls, nonfarm payrolls,
average earnings, and average workweek. Generally, the most significant employment data are
manufacturing and nonfarm payrolls, followed by the unemployment rate.
Employment Cost Index (ECI). The Employment Cost Index measures wages and inflation
and provides a comprehensive analysis of worker compensation, including wages, salaries and fringe
benefits.
Consumer Spending Indicators grounded on data due to the retail sale volume is important for
the Forex because it shows the level of consumers demand and their sentiments, which is initial data
for the calculation of other indicators as Gross National and Gross Domestic Products.
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Retail Sails. Retail sales are a significant consumer-spending indicator for foreign exchange
traders, as it shows the strength of consumer demand as well as consumer confidence. As an economic
indicator, retail sales are particularly important in the United States. Unlike other countries such as
Japan, the focus in the U.S. economy is the consumer. If the consumer has enough discretionary income,
or enough credit for that matter, then more merchandise will be produced or imported. Retail sales
figures create an economic process of "trickling up" to the manufacturing sector.
The seasonal aspect is important for this economic indicator. The retail sales months that are most
watched by foreign exchange traders are December, because of the holiday season, and September, the
back-to-school month. Increasingly, November is becoming an important month, as a result of the shift in
the former after-Christmas sales to pre-December sales days. Another interesting phenomenon occurred
in the United States. Despite the economic recession in the early 1990s, the volume of retail sales was
unusually high. The profit margin, however, was much thinner. The reason is the consumer's shift toward
discount stores.
Traders watch retail sales closely to gauge the overall strength of the economy and, consequently,
the strength of the currency. This indicator is released on a monthly basis.
Consumer sentiment . It’s a survey of households that is designed to gauge direct the individual
propensity for spending money to increase or to maintain on the same level their expenditures
connected with the satisfaction of the household current needs and, by implication, - the situation on
the labor market.
Auto sales. Despite the importance of the auto industry in terms of both production and sales,
the level of auto sales is not an economic indicator widely followed by foreign exchange traders. The
American automakers experienced a long, steady market share loss, only to start rebounding in the early
1990s. But car manufacturing has become increasingly internationalized, with American cars being
assembled outside the United States and Japanese and German cars assembled within the United States.
Because of their confusing nature, auto sales figures cannot easily be used in foreign exchange analysis.
Leading indicators
• The leading indicators consist of the following economic indicators:
• Average workweek of production workers in manufacturing
• Average weekly claims for state unemployment
• New orders for consumer goods and materials (adjusted for inflation)
• Vendor performance (companies receiving slower deliveries from suppliers)
• Contracts and orders for plant and equipment (adjusted for inflation)
• New building permits issued
• Change in manufacturers' unfilled orders, durable goods
• Change in sensitive materials prices
Personal income. It’s the income received by individuals, nonprofit institutions, and private trust
funds. Components of this indicator include wages and salaries, rental income, dividends, interest earnings,
and transfer payments (Social Security, state unemployment insurance, and veterans' benefits). The wages
and salaries reflect the underlying economic conditions. This indicator is vital for the sales sector. Without
an adequate personal income and a propensity to purchase, consumer purchases of durable and nondurable
goods are limited. For FX traders, personal income is not significant.
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3.3. Forex dependence on financial and sociopolitical factors
Financial factors are vital to fundamental analysis. Changes in a government's monetary or
fiscal policies are bound to generate changes in the economy, and these will be reflected in the exchange
rates. Financial factors should be triggered only by economic factors. When governments focus on different
aspects of the economy or have additional international responsibilities, financial factors may have priority
over economic factors. This was painfully true in the case of the European Monetary System (EMS) in the
early 1990s. The realities of the marketplace revealed the underlying artificiality of this approach.
The role of interest rates. Using the interest rates independently from the real economic
environment translated into a very expensive strategy. Because foreign exchange, by definition, consists of
simultaneous transactions in two currencies, then it follows that the market must focus on two
respective interest rates as well. This is the interest rate differential, a basic factor in the markets. Traders
react when the interest rate differential changes, not simply when the interest rates themselves
change. For example, if all the G-5 countries decided to simultaneously lower their interest rates by
0.5 percent, the move would be neutral for foreign exchange, because the interest rate differentials would
also be neutral. Of course, most of the time the discount rates are cut unilaterally, a move that generates
changes in both the interest differential and the exchange rate. Traders approach the interest rates like any
other factor, trading on expectations and facts. For example, if rumor says that a discount rate will be cut,
the respective currency will be sold before the fact. Once the cut occurs, it is quite possible that the currency
will be bought back, or the other way around. An unexpected change in interest rates is likely to trigger a
sharp currency move.
Other factors affecting the trading decision are the time lag between the rumor and the fact, the
reasons behind the interest rate change, and the perceived importance of the change. The market generally
prices in a discount rate change that was delayed. Since it is a fait accompli, it is neutral to the market. If
the discount rate was changed for political rather than economic reasons, a common practice in the
European Monetary System, the markets are likely to go against the central banks, sticking to the real
fundamentals rather than the political ones. This happened in both September 1992 and the summer
of1993, when the European central banks lost unprecedented amounts of money trying to prop up their
currencies, despite having high interest rates. The market perceived those interest rates as artificially high
and, therefore, aggressively sold the respective currencies. Finally, traders deal on the perceived importance of
a change in the interest rate differential.
Political crises influence. A political crisis is commonly dangerous for the Forex because it
may trigger a sharp decrease in trade volumes. Prices under critical conditions dry out quickly, and
sometimes the spreads between bid and offer jump from 5 pips to 100 pips. Unlike predictable political events
(parliament elections, interstate agreements conclusion etc), which generally take place in an exact time
and give market the opportunity to adopt, political crises come and strike suddenly. Currency traders
have a knack for responding to crises. The traders should react as fast as possible to avoid big losses. They
have not much time to take decisions, often they have only seconds. Return on the market after a crisis is
often problematic.
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4. Technical analysis
4.1. The destination and fundamentals of technical analysis
Technical analysis is being used for the prediction of market movements (that is alterations in
currencies prices, volumes and open interests) outgoing from the information obtained for the past. The
main instruments of the technical analysis are different kinds of charts, which represent currencies price
change during a certain time preceding exchange deals, as well as technical indicators. The latter are being
obtained as a result of the mathematical processing of averaged and other characteristics of price
movements. The instruments of the technical analysis are universal and applicable to any Forex sector, any
currency and any time span.
Technical analysis is easy to compute what is important while the technical services are
becoming increasingly sophisticated and reasonably priced. They are available to all the Forex
participants independent on their trade plans, strategies applied and the time of position continuance.
Under contemporary conditions it is executed by means of computers, which is important if to
account that means of the electronic support become more and more sophisticated.
Dow theory
The fundamental principles of technical analysis are based on the Dow Theory with the
following main thesis:
1. The price is a comprehensive reflection of all the market forces. At any given time, all market
information and forces are reflected in the currency prices (“The market knows everything”).
2. Price movements are trend followers (“Trend is your friend”); trends are classified as up trends
(bullish), downtrends (bearish) and flat (sideways). Examples of mentioned trends are given on Figures
4.1 – 4.3.
3. Price movements are historically repetitive (“The history repeats”) which results periodical
emerging the same patterns on the charts.
4. The market has three trends: the longest (about 1 year) major, or primary, less enduring (1 month and
more) intermediate, or secondary, and rather short (several days or weeks) minor. The primary trend has
three phases: accumulation, run-up/run-down, and distribution. In this way, in the accumulation
phase of a bullish market the shrewdest traders enter new positions. In the run-up/run-down
phase, the majority of the market finally "sees" the move and jumps on the bandwagon. Finally,
in the distribution phase, the keenest traders take their profits and close their positions while the
general trading interest slows down in an overshooting market. The secondary trend is a
correction to the primary trend and may retrace one-third, one-half or two-thirds from the
primary trend. In frame of a major trend may be any amount of secondary or minor trends.
The structure of a bullish trend is shown on Figure 4.5.
5. Trends exist until it is not broken (See Figures 4.2, 4.3) and their reversals are confirmed. Figure 4.4
shows example of reversals in a bearish currency market. The buying signals occur at points A and
В when the currency exceeds the previous highs.
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Figure 4.1. Example of a bullish trend in the Japanese yen chart.
Figure 4.2. Example of a bearish trend and a break in the Euro chart.
6. Volume must confirm the trend. Volume consists of the total amount of currency traded within a
period of time, usually one day. Large trading volume suggests that there is interest and liquidity in
a certain market, and low volume warns the trader to close positions. Open interest is the total
exposure, or outstanding position, in a certain instrument. Volume and open interest figures are
available from different sources, although one day late such as the newswires (Bridge Information
Systems, Reuters, Bloomberg), newspapers (the Wall Street Journal, the Journal of Commerce),
weekly printed charts ( Commodity Perspective, Commodity Trend Service).
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Figure 4.3. Example of sideways and breaks in the Euro chart
B
Figure 4.4. Diagram of the bearish market reversal.
Figure 4.5. Diagram of the bullish trend structure: the left side – the major trend with intermediate trends, the bottom part of the left
side – minor trends of the encircled secondary trend.
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Percentage measures of price reversals. The price of a foreign currency even on the strongest
trends is never moving constantly up or down. Traders watch possible reversals (a change in the
movement direction) at certain points of charts.
There are three following typical points of a possible reversal that can be marked on a chart in
percents against the preceded movements (percentage retrenchments):
1. Along Charles Dow a reversal up traditionally is occurring after the price has passed
down 1/3 (33%), ½ (50%) or 2/3 (66%) of the latest rise up. The reversal after 66%
is considered as a trend correction.
2. Using Fibonacci constants (See Chapter 5) one may wait for a reversal up at the
downtrend points at 0.382 (38%), 0.5 (50%) and 0.618 (62%) of the latest rise up.
3. Along Gann one has to wait for a reversal up after each 1/8 of the latest rise up on
the path down.
4.2. Charts for the technical analysis
Kinds of prices and time units. Charts for the technical analysis are being constructed in
coordinates “price (the vertical axis) – time (the horizontal axis)”. The following kinds of currency
prices represented on charts are being distinguished on Forex:
• open – a price at the beginning of a trade period (year, month, day, week, hour,
minute or a certain amount of one from these units);
• close - a price at the end of a trade period;
• high – the highest from prices observed during a trade period;
• low – the lowest from prices observed during a trade period.
Providing the technical analysis one uses charts for different time units – from 1 year or more
till 1 minute. For instance, the computer program RoyalForex allows to analyze price movements
charts for 1 day, 4 hours, 30 minutes, 15 minutes, 5 minutes and 1 minute. The bigger is a time unit
applied for the chart plotting the bigger is a time span to analyze price movements and to determine
the major trend by means of the chart. For the short trading charts for less time units are more
suitable.
Line chart. The line chart is plotted connecting single prices for a selected time period. The most
popular line chart is the daily chart. Although any point in the day can be plotted, most traders focus on the
closing price, which they perceive as the most important. (See Figure 4.6). But an immediate problem with
the daily line chart is the fact that it is impossible to see the price activity for the balance of the period as
well as gaps (See chapter 4.6) – breakups in prices at joints of trade periods. Nevertheless, line charts
are easier to visualize. Also, technical analysis goes well beyond chart formation; in order to execute
certain models and techniques, line charts are better suited than any of the other charts.
Bar chart. The bar chart consists from separate histograms (See figure 4.7). To plot a
histogram in coordinates price – time the points responding to high, low, open and close prices for a
time period analyzed should be marked on the one vertical bar. The opening price usually is marked
with a little horizontal line to the left of the bar; and the closing price is marked with a little horizontal
line to the right of the bar.
Bar charts have the obvious advantage of displaying the currency range for the period selected.
An advantage of this chart is that, unlike line charts, the bar chart is able to plot price gaps. Hence, it is
impossible to see on a bar chart absolutely all price movements during the period.
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Figure 4.6. Example of a line chart of the Swiss franc.
Figure 4.7. Example of histograms plotted in the Swiss franc chart.
Candlestick chart. The candlestick chart is closely related to the bar chart. It also consists of four
major prices: high, low, open, and close (See Figure 4.8). In addition to the common readings, the candlestick
chart has a set of particular interpretations. The latter is possible thanks to the convenient visual observation
of that chart.
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Figure 4.8. Example of a candlesticks plotted in the Swiss franc chart.
The opening and closing prices form the body (jittai) of the candlestick. To indicate that the
opening was lower than the closing, the body of the bar is left blank. Current standard electronic displays
allow you to keep it blank or select a color of your choice. If the currency closes below its opening, the
body is filled. In its original form, the body was colored black, but the electronic displays allow you to
keep it filled or to select a color of your choice.
The intraday (or weekly) direction on a candlestick chart can be traced by means of two "shadows":
the upper shadow (uwakage) and the lower shadow (shitakage). Just as with a bar chart, the candlestick
chart is unable to trace every price movement during a period's activity.
4.3. Lines of trends, support and resistance
The trendline. A trendline is a main initial element for the price chart analysis. While the market
moves in any direction not along a straight line but along a zigzag, the mutual placement of upper and
bottom points of those zigzags permits to plot a line connecting the significant highs (peaks) or the
significant lows (troughs) of an appropriate zigzag using technical tools of the computer program (See
Figures 4.1 – 4.3). To draw a trendline only two points are necessary and the third one is the contact point
confirmation. On a bullish trend chart it should be drawn using troughs, on a bearish – using peaks. The
trendline and a line which is about parallel to it and drawn on the opposite side (through peaks on a dullish
trend and through troughs on a bearish) form the trade channel. Both lines are then channel’s borders.
Examples of trade channels are shown on Figures 4.9, 4.10.
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Figure 4.9. Example of a bullish trade channel plotted in the Swiss franc chart.
Lines of support and resistance. The upper and the bottom borders of trade channels are
called accordingly support and resistance lines. The peaks represent the price levels at which the selling
pressure exceeds the buying pressure. They are known as resistance levels. The troughs, on the other hand,
represent the levels at which the selling pressure succumbs to the buying pressure. They are called support
levels. In an uptrend, the consecutive support and resistance levels must exceed each other respectively.
The reverse is true in a downtrend. Although minor exceptions are acceptable, these failures should be
considered as warning signals for trend changing.
Figure 4.10. Example of a bearish channel and his break plotted in the Japanese yen chart.
The significance of trends is a function of time and volume. The longer the prices bounce off the
support and resistance levels, the more significant the trend becomes. Trading volume is also very
important, especially at the critical support and resistance levels. When the currency bounces off these
levels under heavy volume, the significance of the trend increases.
The importance of support and resistance levels goes beyond their original functions. If these
levels are convincingly penetrated, they tend to turn into just the opposite. A firm support level, once it is
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penetrated on heavy volume, will likely turn into a strong resistance level. (See Figure 4.11). Conversely,
a strong resistance turns into a firm support after being penetrated. (See Figure 4.2).
In general, to evaluate the reliability (that is the possibility of a break) of the trade channel borders
taking a decision to close or to save an existing position one should govern himself with following rules:
1. A channel is the more reliable the longer it exists. Hence, the “solidity” of very old channels (e.g.
existing more than 1 year) decreased sharply.
2. A channel is the more reliable the more is his width (“It takes time to break channel”).
3. The resistance may be broken if it is bounced on the background of a growing volume (“It takes
volume to break resistance”).
4. A steep channel is less reliable in compare to a gentle one.
5. The support may be broken independent on the volume (“under own weight”).
Figure 4.11. Example of resistance turned into support in the Pound Sterling chart.
Figure 4. 12. Example of support turned into resistance in the Japanese yen chart.
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4.4. Trend Reversal Patterns
Independent, which time unit, is applied price movement charts form different kinds of
periodically repeating equal patterns. Some of those patterns always occur on charts before the trend
reversal when the volume is significantly decreasing or increasing. Such formations known as
reversal patterns are considered below.
Head-And-Shoulders. The head-and-shoulders pattern is one of the most reliable and wellknown
chart formations. It consists of three consecutive rallies (See Figure 4.13). The first and third
rallies—the shoulders—have about the same height, and the middle one—the head—are the highest. All
three rallies are based on the same support line (or on the resistance line in the case of the reversed head-andshoulders
formation), known as the neckline. A real example of the head-and-shoulders pattern is shown on
the Figure 4.14.
Figure 4.13. Diagram of a typical Head-And-Shoulders pattern.
Prior to point A, the neckline was a resistance line. Once the resistance line was broken, it turned
into a significant support line. The price bounced off it twice, at point’s В and C. The neckline was
eventually broken in point D, under heavy volume, and the trend reversal was confirmed. As the
significant support line was broken, a retrenchment could be expected to retest the neckline (E), now a
resistance line again. If the resistance line held, the price was expected to eventually decline to around
level F, which was the price target of the head-and-shoulders formation. The target was approximately
equal in amplitude to the distance between the top of the head and the neckline. The price target was
measured from point D, where the neckline was broken (line DF on Figure 4.13).
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Figure 4.14. Example of a real head-and-shoulders pattern in the Pound Sterling chart.
Signals generated by the head-and-shoulders pattern. The head-and-shoulders formation provides
excellent information:
1.The support line. This is based on point’s В and C.
2. The resistance line. After giving in at point D, the market may retest the neckline at point E.
3. The price direction. If the neckline holds the buying pressure at point E, then the formation
provides information regarding the price direction: diametrically opposed to the direction of the head-andshoulders
(bearish).
4. The price target. This is provided by the confirmation of the formation (by breaking through
the neckline under heavy trading volume).
One of the main requirements of the successful development of this formation is that the breakout
through the neckline occurs under heavy market volume. A breakout on light volume is a strong warning
that it is a false breakout and will trigger a sharp backlash in the currency price. The time frame for this
chart formation's evolution is anywhere from several weeks to several months. The intraday chart formations
are not reliable.
Inverted Head-And-Shoulders. The inverted head-and-shoulders formation is a mirror image of
the previous pattern. (See a diagram on Figure 4.15 and a real example on Figure 4.16). Therefore, you can
apply the same characteristics, potential problems, signals, and trader's point of view from the preceding
presentation. The underlying currency broke out of the downtrend ranged by the xx'-yy' channel. The
currency retested the previous resistance line (the rally number 3), now turned into a support line. Among
the three consecutive rallies, the shoulders (1 and 3) have approximately the same height, and the head is
the lowest. Prior to point A, the neckline was a support line. Once this line was broken, it turned into a
significant resistance line. The price bounced off the neckline twice, at point’s В and C. The neckline was
eventually broken at point D, under heavy volume. As the significant resistance line was broken, a
retrenchment could be expected to retest the neckline (E), now a support line again. If it held, the price
was expected to eventually rise to around level F, which is the price target of the head-and-shoulders
formation. The price objective is approximately equal in amplitude to the distance between the top of the
head and the neckline, and is measured from the breakout point, D.
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Figure 4.15. Diagram of a typical inverted head-and-shoulders pattern.
Figure 4.16. An example of an inverted head-and-shoulders pattern in the Swiss franc chart.
Double Top. Another very reliable and common trend reversal chart formation is the double
top. As the name clearly and succinctly describes, this pattern consists of two tops (peaks) of
approximately equal heights (See Figures 4.17 and 4.18). As it is shown on the Figure 4.17, a parallel line is
drawn against a resistance line that connects the two tops. We should think of this line as identical to the
head-and-shoulders' neckline. As a resistance line, it is broken at point A. It turns into a strong support for
price level at C, but eventually fails at point E. The support line turns into a strong resistance line, which
holds the market backlash at point F. The price objective is at level G, which is the average height of the
double top formation, measured from point E.
Signals provided by the double top formation. The double top formation provides information
on:
1. The support line, set between points A and E.
2. The resistance line, set between points В and D.
3. The price direction. If the neckline holds the buying pressure at point F, then the formation
provides information regarding the price direction: diametrically opposed to the direction of the
peaks (bearish).
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4. The price target, provided by the confirmation of the formation (by breaking through the neckline
under heavy trading volume.)
Exactly as in the case of the head-and-shoulders pattern, a vital requirement for the successful
completion of the double-top formation is that the breakout through the neckline occurs under heavy
market volume. A breakout on light volume is a strong case for a false breakout, which would trigger a
sharp backlash in the currency price. The time frame for this chart formation's evolution is anywhere from
several weeks to several months. The intraday chart formations are less reliable. There is a strong correlation
between the length of time to develop the pattern and the significance of the formation.
The target is unlikely to be reached in a very short time frame. There is no direct suggestion regarding
the length of target reaching time; but foreign exchange common sense links it to the duration of development.
It is important to measure the target from the point where the neckline was broken. Avoid the trap of
measuring the target price from the middle of the formation under the neckline. This may happen as you
measure the average height of the formation.
Neckline
Figure 4.17. Diagram of a typical double-top formation.
Figure 4.18. An example of a double-top formation in the Swiss franc chart.
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Double Bottom. The double bottom formation is a mirror image of the previous pattern (See
Figures 4.19 and 4.20). Therefore, one may apply the same characteristics, potential problems, signals, and
trader's point of view from the preceding presentation. As it is shown on Figure 4.19, the bottoms have about
the same amplitude. A parallel line (the neckline) is drawn against the line connecting the two bottoms
(B and D.) As a support line, it is broken at point A. It turns into a strong resistance for price level at C,
but eventually fails at point E. The resistance line turns into a strong support line, which holds the market
backlash at point F. The price objective is at level G, which is the average height of the bottoms,
measured from point E.
Neckline
Figure 4.19. Diagram of a typical double-bottom formation.
Figure 4.20. An example of a double-bottom formation in the Swiss franc chart.
Triple Top. The triple top is a hybrid of the head-and-shoulders and double-top trend reversal
formations (See Figures 4.21 and 4.22). Consequently, they have the same characteristics, potential
problems, signals, and trader's point of view as the double top or double bottom, respectively.
As shown in Figure 4.21, in a typical triple-top formation, the tops have about the same height. A
parallel line (the neckline) is drawn against the line connecting the three tops (B, D, and F). As a
resistance line, the neckline is broken at point A. It turns into a strong support for price levels at С and E,
but eventually fails at point G.
The support line turns into a strong resistance line, which holds the market backlash at point H.
The price objective is at level I, which is the average height of the three tops formation, as measured from
point D. As a double top, the formation fails at point E. The price moves up steeply toward point F. The
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36
resistance line is holding once more and the price drops sharply again toward point G. At this level, the
market pressure is able to penetrate the support line. After a possible retest of the neckline, the prices drop
further, to eventually reach the price objective.
B
Neckline
Figure 4.21. Diagram of a triple-top formation.
Figure 4.22. An example of a triple-top formation in the Japanese yen chart.
Triple Bottom. Triple Bottom is a hybrid of the double top and inverted head-and-shoulders
patterns (See Figures 4.23 and 4.24). As shown in Figure 4.23, in a triple-bottom formation, the
bottoms have about the same amplitude. A parallel line (the neckline) is drawn against the line
connecting the three bottoms (B, D, and F). As a support line, the neckline is broken at point A. It turns
into a strong resistance for price levels at С and E, but eventually fails at point G. The resistance line
turns into a strong support line, which holds the market backlash at point H. The price objective is at
level I, which is the average length of the triple-bottom formation, as measured from point D.
Neckline
Figure 4.23. Diagram of a typical triple-bottom formation.
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Figure 4.24. An example of a triple-bottom formation in the Japanese yen chart.
The head-and-shoulders, the double top and bottom and the triple top and bottom, due to their
significance in trend reversals, are generally known as major reversal patterns.
Rounded Top, Rounded Bottom, Saucer, Inverted Saucer. Rounded Top (See Figure 4.25),
Rounded Bottom (See Figure 4.26), Saucer (See Figure 4.27) and Inverted Saucer (See Figure 4.28)
patterns form as a result of a slow and gradual change in the direction of the market. These patterns reflect
the indecision of the market at the end of a trend. The trading activity is slow. It is impossible to know
when the formation is indeed completed, and not for a lack of trying. Though is known that the longer it
takes to complete patterns, the higher is the likelihood of a sharp price move in the new direction.
Figure 4.25. An example of a rounded top formation in the Japanese yen chart.
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Figure 4.26. An example of a rounded bottom formation in the Pound Sterling chart.
Figure 4.27. An example of a saucer formation in the Pound Sterling chart.
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Figure 4.28. An example of an inverted saucer formation in the Pound Sterling chart.
4.5. Trend Continuation Patterns
Technical analysis provides charts that reinforce the current trends. These chart formations are
known as continuation patterns. They consist of fairly short consolidation periods. The breakouts occur in
the same direction as the original trend. The most important continuation patterns are:
1. Flags.
2. Pennants.
3. Triangles.
4. Wedges.
5. Rectangles.
Flags. The flag formation provides signals for direction and price objective. This formation
represents a brief consolidation period within a solid and steep upward or downward trend. The
consolidation itself is bordered by a support line and a resistance line, which are parallel to each other or
very mildly converging, making it look like a flag (parallelogram) and tends to be sloped in the opposite
direction from the slope of the original trend, or is simply flat. The previous sharp trend resembles a
flagpole. If the original trend is going down, the formation is called a bearish flag (See Figures 4.29 and
4.30). As Figure 4.29 shows, the original trend is sharply down. The flagpole is measured between points A
and B. The consolidation period occurs between the support line ВE and the resistance line СD. When the
price penetrates the support line at point E, the trend resumes its fall, with the price objective F, measured
from E. The price target is of about equal with the flagpole's length AB, measured from the breakout point
through the support line BE. Outgoing from prices in Figure 4.29, the height of the flagpole is measured as the
difference between 140.00 - 120.00 = 20.00. Once the support line is broken at 125.00, the price target is
125.00 – 20.00 = 105.00.
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140.00
B
105.00
Figure 4.29. Diagrams of a bear flag formation.
Figure 4.30. Example of bullish flags in the Swiss franc chart.
Pennants. The pennants are closely related to the flags, so the same principles apply. The sole
difference is that the consolidation area better resembles a pennant, as the support and resistance lines
converge. If the original trend is bullish, then the chart pattern is a bullish pennant. In Figure 4.31, the
pennant pole is AВ. С, В, and D frame the pennant-shaped consolidation. When the market breaks
through the resistance line ВD, the price objective is E. The amplitude of the target price is D to E, and
it is equal to the pennant pole A to B. The price target measurement starts from the breakout point. Outgoing
from prices in Figure 4.31, the height of the pennant pole is measured as the difference 1.5500 - 1.4500 =
1.1000. Once the resistance line is broken at 1.5200, the price target is 1.5200 +1.1000 = 1.6200.
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Figure 4.31. Diagrams of a bullish pennant.
If the original trend is going down, then the formation is a bearish pennant. In Figure 4.32, the
pennant pole is AВ. С, В and D frame the pennant-shaped consolidation. When the market breaks
through the support line ВD, the objective price is E. The amplitude of the target price is DE, and it is equal
to the pennant pole AB. The price target measurement starts from the breakout point.
Outgoing from prices in Figure 4.32, the height of the flagpole is measured as the difference
139.00 - 119.00 = 20.00. Once the support line is broken at 120.00, the price target is 120.00 – 20.00 =
100.00.
A market example of a bearish pennant is presented on Figure 4.33.
120.00
B 119.00
100.00
Figure 4.32. Diagrams of a bearish pennant.
1.6200
1.4500
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Figure 4.33. A real example of a bearish pennant in the Japanese yen chart.
Triangles. Triangles can be considered as pennants with no poles. There are four types of
triangles: symmetrical, ascending, descending, and expanding (broadening.)
A symmetrical triangle consists of two symmetrically converging support and resistance lines,
defined by at least four significant points (See Figures 4.34 and 4.35). The two symmetrically converging
lines suggest that there is a balance between supply and demand in the foreign exchange market.
Consequently, a break may occur on either side. Hence, in the case of a bullish symmetrical triangle, the
breakout will likely occur in the same direction, qualifying the formation as a continuation pattern.
As Figure 4.34 shows, the converging lines are symmetrical. Points B, D, and F define the declining
line. Points A, C, E, and G define the rising support line. The price target is either equal to the width of the
base of the triangle BB', measured from the breakout point H (HH'); or at the intersection of line BI
(which is a parallel line to the rising line AG) with the price line. Trading volume will visibly decrease
toward the end of the triangle, suggesting the ambivalence of the market. The breakout is accompanied by a
rise in volume.
Outgoing from prices in Figure 4.34, the price objective is either 1.5500, as the difference 1.5000 -
1.4000 = 0.1000 added to 1.4500; or 1.5300, as the difference between 1.5000 - 1.4000 = 0.1000, added
to 1.4300. A currency market example is presented in Figure 4.35.
B
1.5300
1.5300
Figure 4.34. Diagrams of a bullish symmetrical triangle.
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Figure 4.35. A real example of symmetrical triangles in the Euro chart.
From triangles of other kind the descending triangle is considered below. It consists of a flat
support line and a downward sloping resistance line (See Figure 4.36). This pattern suggests that supply is
larger than demand. The currency is expected to break on the downside. The descending triangle also
provides a price objective. Measuring the width of the triangle base and then transposing it to the
breakpoint calculate this objective. As shown in Figure 4.36, the support line, defined by points A, C, E,
and G, is flat. The converging top line, defined by points B, D, F, and H, is sloped downward. The price
objective is the width of the base of the triangle (AA'), measured above the support line from the
breakout point I (IF.)
Outgoing from prices on Figure 4.36, the price objective is 1.3000, as the difference 1.5000 -
1.4000 = 0.1000 subtracted from 1.4000.
Trading volume is decreasing steadily toward the tip of the triangle, but increases rapidly on the
breakout.
The expanding (broadening) triangle, or the megaphone consists of a horizontal mirror image of a
triangle, where the tip of the triangle is next to the original trend, rather than its base (See Figure 4.37).
Volume also follows the horizontal mirror image switch and increases steadily as the chart formation
develops. As shown in Figure 4.37, the bottom support line, defined by points B, D, and F, and the top
line, defined by points A, C, and E, are divergent. The price objective should be the width, GG', of the
base of the triangle, measured from the breakout point G.
Outgoing from prices on Figure 4.37, the price objective is 102.00, as the difference between 101.00 -
100.00 = 1.00 subtracted from 101.00. A real example of the megaphone is shown in Figure 4.38.
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Figure 4.36. Diagrams of a descending triangle.
102.00
101.00
1 100.00
Figure 4.37. Diagrams of an expanding triangle.
Figure 4.38. A real example of megaphone formation in the Pound Sterling chart.
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Wedges. The wedge formation is a close relative of the triangle and the pennant formations. It
resembles both the shape and the development time of the triangles, but it really looks and behaves like a
pennant without a pole. The wedge is markedly sloped, and the breakout occurs in the direction opposite
to its slope (See Figures 4.39 and 4.40), but similar to the direction of the original trend. The signal we
receive from the wedge formation is direction only. There is no reliable price objective. Depending on the
trend direction, there are falling and rising types of wedges (as in Figure 4.39).
Figure 4.39. Diagrams of a falling (in a bullish trend) and a rising (in a bearish trend) wedges.
Figure 4.40. Example of a falling wedge in a bullish trend in the Japanese yen chart.
Rectangles . The rectangle formation reflects a consolidation period. Upon breakout, it is likely
to continue the original trend. Its failure will change it from a continuation to a reversal pattern. This
pattern is easy to spot, as it can be considered a minor side-ways trend.
If it occurs within an up-trend and the breakout occurs on the upside, it is called a bullish rectangle
(See Figure 4.41). The price objective is the height of the rectangle. As Figure 5.56 shows, the currency
moves between well-defined, flat support and resistance levels. A valid breakout may occur on either
side from this consolidation period. The price target (GH) is equal to the height of the rectangle (G'H),
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measured from the breakout point H. Outgoing from prices in Figure 4.41, the price objective is 1.6200, as
difference 1.6100 - 1.6000 = 0.0100, added to 1.6100.
If the consolidation occurs within a downtrend and the breakout continues the original trend, then it
is called a bearish rectangle (See Figure 4.42). As shown in Figure 4.42, the currency moves between
well-defined, flat support and resistance levels. A valid breakout may occur on either side of this
consolidation on period. The price objective (HG') is equal in size to the height of the rectangle (GH),
measured from the breakout point H. In the numerical example, the price objective is 100.00 (difference
102.00 - 101.00 = 1.00, subtracted from 101.00).
1.6200
A C E
Figure 4.41. Diagrams of a typical bullish rectangle
102.00
101.00
100.00
Figure 4. 42. Diagram of a typical bearish rectangle
Figure 4.43. Example of a bearish rectangle in the Euro chart.
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4.6. Gaps
Gaps in the technical analysis are named interruptions between close and open prices visualized
in bar charts and candlesticks charts. Such a way, an opening outside the previous day's or other
period's range generates a price gap. There are four types of gaps: common, breakaway, runaway, and
exhaustion. It is commonly believed that "Gaps must be filled." as a result of the price reversal just after a gap
formation. Hence, the time of gap filling may be essentially different for different types of gaps.
Common Gaps. Common gaps tend to occur in relatively quiet periods or in illiquid markets. Common
gaps are as a rule short term that is it may soon close indeed. When gaps occur within regular trading
ranges, the word on the street has been that, "Gaps must be filled". Emerging of a common gap in a rise price
chart is a signal buy, in a down price chart – sell. Examples of common gaps are shown on Figures 4.44 and 4.45.
As one can see on these figures, the most gaps on charts were closed indeed in filling time up to 12 hours.
Figure 4.44. Example of common gaps filling in the Japanese yen chart.
.
Breakaway Gaps. Breakaway gaps occur at the beginning of a new trend, usually after the break of
a consolidation pattern. Breakaway gaps indicate most likely direction of the trend continuation and confirm
a potential of the market. Examples of breakaway gaps are shown in the Figures 4.46 and 4.47.
Figure 4.45. Example of common gaps in the Japanese yen chart.
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Figure 4.47. Example of a breakaway gap after a bullish wedge in the the Japanese yen chart.
Runaway Gaps. Runaway, or measurement gaps occur within solid trends, which develop fast.
They are known as measurement gaps because they tend to occur about midway through the life of a
trend. Thus, if you measure the total range of the previous trend and extrapolate it from the measurement
gap, you can identify the end of the trend and your price objective. Since the velocity of the move should be
similar on both sides of the gap, you also have a time frame for the duration of the trend. Examples of those
gaps are shown on Figures 4.48 – 4.50.
Figure 4.47. Example of a breakaway gap after a bearish channel in f the Swiss franc chart.
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Figure 4.48. Example of a runaway gap in the Pound Sterling chart.
Exhaustion Gaps. Exhaustion gaps may occur at the top or bottom of a formation when trends
change direction in an atypically quick manner. Gaps of that kind indicate on the direction of next
movement of the market and reflect a sudden change in the demand-supply ratio. By a relatively slow
reversal of the market you may wait on two exhaustion gaps to left and to right from a consolidation
figure when so called exhaustion island is being formed.
Figure 4.49. Example of a runaway gap in the Pound Sterling chart.
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Figure 4.50. Example of a runaway gap in the Japanese Yen chart.
Real examples of an Exhaustion Gap and Exhaustion Island are shown on Figures 4.51 and
4.52.
Figure 4.51. Example of a exhaustion gap in the Pound Sterling chart.
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Figure 4.52. Example of an exhaustion island in the Japanese yen chart.
4.7. Mathematical tools for the technical analysis (Technical indicators)
The quantitative, or mathematical tools for the technical analysis called the technical indicators
are being obtained as a result of the mathematical processing of prices averaged in time as well as
other characteristics of market movements. They are applied to get signals for an additional
evaluation of trade channels and patterns analysis by means of the indicators charts. The main groups
of technical indicators are moving averages and oscillators.
Moving Averages. A moving average is an average price of a certain currency over a certain time
interval (in days, hours, minutes etc) during an observation period divided by these time intervals. This
averaged price is being determined consequently for each regular interval beginning from the first. A
moving average has a smoother line than the underlying currency because statistical ‘noises’ are excluded
to provide more convenient visualization of the currency activity. A moving average may be used as a
special indicator or to create an oscillator. The moving average may be based on the midrange level or on
a daily average of the high, low, and closing prices. The charts of moving averages are being plotted within
same coordinates with an underlying price chart (See Figures 4.53 – 4.56).
In the technical analysis are known the next three types of moving averages:
1. The simple moving average or arithmetic mean (SMA).
2. The linearly weighted moving average (LMA). This type of average assigns more weight to the
more recent closings. This is achieved by multiplying the last day's price by one, and each closer
day by an increasing consecutive number. In our previous example, the fourth day's price is
multiplied by 1, the third by 2, the second by 3, and the last one by 4; then the fourth day's price is
deducted. The new sum is divided by 9, which is the sum of its multipliers.
3. The exponentially smoothed moving average (EMA) which provides the best smoothing of data
averaged taking into account the previous price information of the underlying currency.
In Figure 4.53 is shown the difference in reading of different types of moving averages.
Trading signals of moving averages. Trade signals which occur by the use of one moving
average is a buy signal by the crossing of the underlying price chart by the moving average chart
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from below up and a sell signal by the crossing of the underlying price chart by the moving average
chart from above down (See Figure 4.54).
Figure 4.53. The underlying price chart (blue) and charts of a 9 days moving average (red – SMA, brown – LMA, green
– EMA) in the Swiss franc chart.
Figure 4.54. Trade signals (the underlying price chart – blue line, the moving average chart - red): the first and second
crossing – signals buy, the third and forth – sell.
For the technical analysis applied are usually two or three moving averages charts constructed
for different periods – long term, middle term and short term. For example to use two charts a
combination of moving averages for 4 and 9 days and to use three moving averages – for 4, 9 and 18
days may be applied. Other often-applied combinations of three moving averages are 5, 20 and
60days and 7, 21 and 90 days.
A buying signal on a two-moving average combination, for example for 4 and 9 days, occurs
when the shorter term of two consecutive averages (4 days) intersects the longer (9 days) upward. A selling
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signal occurs when the reverse happens, and the longer of two consecutive averages intersects the
shorter one downward (See Figure 4.55).
Figure 4.55. Trade signals (from left to right) by the use of two EMA in the Swiss franc chart (the underlying price chart –
blue line, moving averages charts: red – for 4 days, green – for 9 days): the first crossing –buy signal, the second– sell
signal
A signal involving three moving averages is generated by a moving averages combination of 4,
9, and 18 days. The buying warning occurs when the 4-day moving average crosses upward both the
9-day and 18-day averages, and the buying signal is confirmed when the 9-day moving average also
crosses upward the 18-day average. (See Figure 4.56). The reverse is true for the selling signal.
Figure 4.56. Trade signals (from left to right) by the use of three EMA in the Swiss franc chart (the underlying price chart
– blue line, moving averages charts: red – for 4 days, green – for 9 days, brown – for 18 days): the first crossing –buy
signal, the second– sell signal.
Envelopes. The envelope model consists of a short-term (perhaps 5-day) closing price based moving
average to which you add and subtract a small percentage (2 percent is suggested for foreign currencies). An
example for the envelope using the averaging along 14 days intervals is shown on the figure 4.57. The crossing of
the underlying chart price by the envelope chart from above down is a buy signal.
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Figure 4.57. The underlying price (blue line) and the Envelop indicator (black lines) in the Swiss franc chart.
Ballinger Bands. The Ballinger bands combine a moving average with the instrument's volatility.
The bands were designed to gauge whether prices are high or low on a relative basis via volatility. The two
are plotted two standard deviations above and below a 20-day simple moving average.
The bands look a lot like an expanding and contracting envelope model. When the band
contracts drastically, the signal is that volatility is low and thus likely to expand in the near future. An
additional signal is a succession of two top formations, one outside the band followed by one inside. If it
occurs above the band, it is a selling signal. When it occurs below the band, it is a buying signal (See Figure
4.58).
Median Price. The Median Price indicator chart is being plotted using arithmetical averages
of high and low for a trade period prices. An example of that indicator is shown on Figure 4.59. The
superposition of an underlying price chart with the indicator chart gives a visual representation about
the grade and direction of the deviation of close prices from the averaged prices during an
observation interval.
Average True Range. The indicator Average True Range denoted in the USA, as ATR is a
grade of the volatility. Minimal and maximal values of the volatility are signals warning about a
possible reversal.
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Figure 4.58. The underlying price (blue line), EMA (red line) and the Ballinger Bands indicator (black lines) in
the Swiss franc chart.
Figure 4.59. An example of the Median Price indicator (red line) in the Swiss franc chart.
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Figure 4.60. An example of the ATR indicator (red line) in the Swiss franc chart.
As it is shown in Figure 4.60 with an example of the ATR indicator for 14 days, declining of
the volatility in the ATR chart till a minimal from all visible values was a prediction of the coming
after it bearish price reversal.
Oscillators. Oscillators were designed to provide signals regarding overbought and oversold
market conditions. Therefore the signals of oscillators are mostly useful at the extremes of their scales.
Crossing the zero line, when applicable, usually generates direction signals. The major types of oscillators
provided by the RoyalForex program are considered below.
Commodity Channel Index. The commodity channel index (CCI) consists of the difference
between the mean price of the currency and the average of the mean price over a predetermined period of
time. A buying signal is generated when the price exceeds the upper (+100) line, and a selling signal
occurs when the price dips under the lower (-100). An example of this indicator is shown in Figure 4.61.
As one can see in this Figure, the CCI oscillates around 0 in the interval from -100 till +100. Values
CCI>100 tells about an overbought (position sell likes to be rational), a value CCI<100 k =" [(CCL" d="(H3/L3)" h3 =" CCL" l3=" H3" m="CCP-OCP,">100 one says “The market caught a moment”, otherwise
(M<100)“The market lost a moment”. A real example of the Momentum indicator for 14 days is
shown in Figure 4.65. Maximal values of the indicator show the overbought, minimal – oversold
market conditions. In terms of time frame, needless to say, the shorter the number of days included in
the calculations, the more responsive the momentum will be to short-term fluctuations, and vice versa.
Figure 4.64. Example of a real MACD indicator chart in the Swiss Franc chart.
Figure 4.65. Example of a real Momentum indicator chart in the the Swiss franc chart.
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Relative Strength Index. The Relative Strength Index (shortly called as RSI) measures the
relative changes between the highest and lowest close prices (See Figure 4.66).
The formula for calculating the RSI is:
RSI=100-[100/(1+RS)],
Where
RS - average of predetermined number X trade periods value of all closes, which were higher than all preceded
closes divided by average of the same X priodss value of all closes, which were lower than all preceded closes.
Most often RSI is calculated for 14 days. RSI charts are plotted on a 0 to 100% scale. The 70%
and 30% values are used as warning signals, whereas values above 85% indicate an overbought condition
(sell signal) and values under 15 indicate an oversold condition (buy signal). By the technical analysis
RSI is effectively used together with Ballinger Bands. It is believed that a sell position should be open
when by a high RSI value the price chart touches with the upper Ballinger Band, and a buy position –
when by a low RSI value the price chart touches with the bottom band. A real example of an RSI
indicator for 14 days together with the Ballinger Bands indicator is shown in Figure 4.66.
Figure 4.66. Example of real RSI and Ballinger Band indicators in the Swiss Franc chart
Rate of Change. The Rate of Change (shortly – ROC) is another version of the Momentum
oscillator. The difference consists in the fact that, while the Momentum's formula is based on
subtracting the oldest close price from the most recent, and the ROC's formula is based on dividing the
oldest close price into the most recent one:
ROC = (CCP/OCP) * 100,
Where
CCP - current close;
OCP – the oldest close price for the predetermined period.
A real example of the ROC for 14 days is shown in Figure 4.67.
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Figure 4.67. Example of a real ROC indicator on the f the Swiss Franc chart.
Larry Williams Percent Rate. The Larry Williams Percent Rate (Williams %R) is a version of
the stochastic oscillator. It consists of the difference between the highest high price of a
predetermined number of days and the current close price, which difference in turn is divided by the total
range. This oscillator is plotted on a reversed 0 to 100% scale (See a real example in Figure 4.68).
Therefore, the bullish reversal signals occur at fewer than 80%, and the bearish signals appear at above
20%. The interpretations are similar to those discussed under stochastic.
Figure 4.68. Example of a real W%R indicator on the of the Swiss Franc chart.
It is rational to use for a detailed technical analysis a combination of different indicators from
the above mentioned (See Figure 4.69).
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Figure 4.69. Example of the technical indicators combination indicator in the Swiss Franc chart: EMA (red line in the price
chart), RSI (the upper indicator), Stochastic (the middle indicator) and MACD (the bottom indicator).
Ichimoku Kinko Hyo. The Ichimoku Kinko Hyo (or simply - Ichimoku) indicator is
appointed to determine simultaneously a market trend direction, support and resistance levels and to
trigger buy and sell signals. Such a way, this indicator unites in itself a number of other indicators as
well as different approaches concerning with the price movement prediction. To construct an
Ichimoku’s chart four time intervals of different widths are used. On those intervals are grounded
values of the following lines constituting the Ichimoku which are the lines of median prices in a
corresponding interval:
Tenkan-sen – shows the average value of a price of the first time interval which is the sum of
a maximum and minimum of that time, divided by two;
Kijun-sen - shows the average value of a price of the second time interval;
Senkou Span А – shows the middle of a distance between two preceding lines moved ahead on
the value equal the second time interval;
Senkou Span B - shows the average value of a price of the third time interval moved ahead on
the value equal the second time interval;
Chinkou Span - shows the close of a current candlestick moved back on the value equal the
second time interval.
The area between Senkou lines is hatched and called the cloud. If the price chart is inside the
cloud the market is believed trendless, and Senkou lines form support and resistance levels.
If the price chart is above the cloud, the upper cloud border is the first support and the bottom – the
second. If the price chart is under the cloud then the bottom cloud border is the first resistance and the
upper – the second. The crossing of the price chart by the line Chinkou Span bottom-up is a buy –
signal, top-down - sell. Kijun-sen («main line») is used as a gauge of the market movement. If the
price is above this line, a growth of prices is to be expected. If the prices cross this line the further
trend reversal is likely to be expected. The other variant of the
Kijun-sen use is trade signals triggering. A signal buy is generated if the Tenkan-sen line
crosses the Kijun-sen line bottom-up and signal sell – by crossing otherwise. The Tenkan-sen
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("reversal line") is being used as an indicator of the market trend – a trend exists if this line is rising
or falling. A real example of the Ichimoku is presented in Figure 4.70.
Figure 4.70. Example of the Ichimoku indicator with lines Tenkan-sen (of 9 days, red), Kijun-sen (of 26 days, black),
Senkou Span B and A (of 52 days, the cloud’s color), Chinkou Span (of 26 days, green) in the Japanese yen chart. The
trade signals buy and sell are in points of crossing of black and green lines by the red line bottom-up and top-down.
The additional information with regard to technical indicators is represented under the menu
“Additional Materials” of this Web site.
5. Fibonacci constants and Elliott waves theory
5.1 Fibonacci constants
The Fibonacci theory named so after a prominent Italian mathematician of the late twelfth and
early thirteenth centuries gives ratios, which play important role in the forecasting of market
movements. Fibonacci introduced an additive numerical series that has come to be called the Fibonacci
sequence, which consists of following series of numbers:
1, 1, 2, 3, 5, 8, 13, 21, 34,55, 89,144, 233, 377, 610, 987, 1597, 2584,4181, (etc.).
These numbers exhibit several remarkable relationships, in particular the ratio of any term in the
series to the next higher term. This ratio tends asymptotically to 0.618. In addition, the ratio of any term to
the next lower term in the sequence tends asymptotically to 1.618, which is the inverse of 0.618. Similarly
constant ratios exist between numbers two terms apart, three terms apart, and so on. The ratio 0.618,
referred to as the Fibonacci ratio, or the “Gold Spiral” which is being observed in structures of many natural
objects and events – from clam’s construction till the form of whirlwinds and hurricanes.
The financial markets exhibit Fibonacci proportions in a number of ways; particularly they are
powerful tools for calculating price targets and placing stops. For example, if a corrective wave is
expected to retrace 61.8 percent of the preceding impulse wave, an investor might place a stop slightly below
that level. This will ensure that if the correction is of a larger degree of trend than expected, the investor
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will not be exposed to excessive losses. On the other hand, if the correction ends near the target level, this
outcome will increase the probability that the investor's preferred wave interpretation is accurate (See also p.
4.1).
5.2 Elliott waves theory
The Elliott Waves Principle is a system of empirically derived rules about the amount of
ascending and descending waves during the history of a market movement. This theory postulates
that all the market movement consists of cycles containing 8 waves each including five waves in the
direction of the trend at one larger scale and three waves against that trend. In a rising market, this five
wave/three-wave pattern forms one complete bull market/bear market cycle of eight waves. The five-wave
upward movement as a whole is referred to as an impulse wave with sub waves labeled with figures while the
three-wave countertrend movement is described as a corrective wave with sub waves labeled with letters
(See Figure 5.1). Amplitudes of the correction waves subordinate certain rules: a second wave may never
retrace more than 100 percent of a first wave (for example, in a bull market, the low of the second wave
may not go below the beginning of the first wave); the third wave is never the shortest wave in an impulse
sequence, often, it is the longest; a fourth wave can never enter the price range of a first wave (See
Figure 5.2) As the illustration shows, waves of any degree in any series can be subdivided and
resubdivided into waves of smaller degree or expanded into waves of larger degree. Furthermore,
smaller-scale movements link up to create larger-scale movements possessing the same basic form.
Conversely, large-scale movements consist of smaller-scale subdivisions with which they share a
geometric similarity. Because these movements link up in increments of five waves and three waves, they
generate sequences of numbers that the analyst can use (along with the rules of wave formation) to help
identify the current state of pattern development, as shown in Figure 5.3.
Extentions. In any given five-wave sequence, a tendency exists for one of the three impulse sub waves
(i.e., wave 1, wave 3, or wave 5) to be an extension—an elongated movement, usually with internal
subdivisions. At times, these subdivisions are of nearly the same amplitude and duration as the larger
degree waves of the main impulse sequence, giving a total count of nine waves of similar size rather
than the normal count of five for the main sequence (See Figure 5.4). Extensions can provide a useful guide
to the lengths of future waves. Most impulse sequences contain extensions in only one of their three
impulsive sub waves. Thus, if the first and third waves are of about the same magnitude, the fifth wave
probably will be extended, especially if volume during the fifth wave is greater than during the third.
Diagonal Triangles. There are certain patterns resembling known from the technical analysis
theory including two types of triangles, which are to be considered from the Elliott theory position.
The diagonal triangle type 1 occurs only in fifth waves and in С waves, and it signals that the
preceding move has "gone too far, too fast," as Elliott put it. Essentially a rising wedge formation defined
by two converging trend lines, type 1 diagonal triangles indicate exhaustion of the larger movement.
Unlike other impulse waves, all of the patterns' sub-waves, including waves 1, 3, and 5, consist of threewave
movements, and their fourth waves often enter the price range of their first waves, as shown in Figures
5.5 and 5.6. A rising diagonal triangle type 1 is bearish, because it is usually followed by a sharp
decline, at least to the level where the formation began. In contrast, a falling diagonal type 1 is bullish,
because an upward thrust usually follows.
The diagonal triangle type 2 occurs even more rarely than type 1. This pattern, found in firstwave
or A-wave positions in very rare cases, re sembles a diagonal type 1 in that it is defined by converging
trend lines and its first wave and fourth wave overlap, as shown in Figure 5.7. However, it differs
significantly from type 1 in that its impulsive sub waves (waves 1, 3, and 5) are normal, five-wave impulse
waves, in contrast to the three-wave sub waves of type 1. This is consistent with the message of the type 2
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65
diagonal triangle, which signals continuation of the underlying trend, in contrast to the type 1 's message of
termination of the larger trend.
Failures (Truncated Fifths). Elliott used the word failure to describe an impulse pattern in which
the extreme of the fifth wave fails to exceed the extreme of the third wave. Figures 5.8 and 5.9 show
examples of failures in bull and bear markets. As the illustrations show, the truncated fifth wave contains
the necessary impulsive (i.e., five-wave) substructure to complete the larger movement. However, its
failure to surpass the previous impulse wave's extreme signals weakness in the underlying trend, and a
sharp reversal usually follows.
Figure 5.1. Diagram of the basic Elliott Wave.
Figure 5.2. The larger scale pattern of the Elliott wave.
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66
r scale pattern in detail.
Figure 5.3. Diagram of a complete market cycle.
Figure 5.4. Diagrams of Elliott wave extensions.
BULL MARKET BEAR MARKET
FIRST WAVE EXTENSION
THIRD VMK/E EXTENSION
FIFTH WAVE EXTENSION
EXTENSION NOT IDENTIFIED
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67
(3)
(2)
Figure 5.5. Diagram of a bullish pattern.
Figure 5.6. Diagram of a bearish diagonal triangle.
Figure 5.7. Diagram of a bullish diagonal triangle.
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68
Figure 5.8. Diagram of a bullish market failure.
Figure 5.9. Diagram of a bearish market failure.
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69
References
1. Luca C. Trading in the Global Currency Markets.- 2-nd Edition. New York Institute of Finance.-
New York, 1999
2. Luca C. Technical Analysis Applications in the Global Currency Markets.-.- 2-nd Edition. New
York Institute of Finance.- New York, 2000
3. Achelis S.B. Technical Analysis from A to Z. - 2-nd Edition. New York. McGraw-Hill, 2000
4. Reuters. An Introduction to Technical Analysis. – John Wiley & Sons, 1999.
5. Edwards R.D., Magee John. Technical Analysis of Stock Trends.- 7th Edition.-AMACOM, 1998.
6. Эрлих А. Технический анализ товарных и финансовых рынков. Москва, “Инфра – М”,
1996.
7. Colby R.W., Meyers T.A. The Encyclopedia of Technical Market Indicators. Richard D.
Irwin, Inc., 1988.