…rules behind this strategy are specifically developed to take advantage of strong trending markets that make new highs that then proceed to fail by taking out a recent low and then reverse again to make other new highs. This type of setup tends to have a very high success rate as it allows traders to enter strongly trending markets after weaker players have been flushed out, only to have real money players reenter the market and push the pair up to make major highs.
Strategy Rules
Long
1. Look for a currency pair that is making a 20-day high.
2. Look for the pair to reverse over the next three days to make a two-day low.
3. Buy the pair if it takes out the 20-day high within three days of making the two- day low.
4. Place the initial stop a few pips below the original two-day low that was identified in step 2.
5. Protect any profits with a trailing stop or take profit by double the amount risked.
Short
1. f. Look for a currency pair that is making a 20-day low.
2. Look for the pair to reverse over the next three days to make a two-day high.
3. Sell the pair if it trades below the 2-day low within three days of making the two- day high.
4. Risk up to a few ticks above the original two-day high that was identified in step 2.
5. Protect profits with a trailing stop or take profit by double the amount risked.
Examples
Take a look at our first example in Figure 8.19. The daily chart of the GBP/USD shows that the currency pair made a new 20-day high on November 17 at 1.8631.
This means that the currency pair gets onto our radar screens and we prepare to look for the pair to make a new two-day low and then rally back beyond the previous 20- day high of 1.8631 over the…
Figure 8.20 USD/CAD Filtering Fake Breakouts Chart (Source: eSignal. www.eSignal.com)
Figure 8.21 USD/JPY Filtering Fake Breakouts Chart (Source: eSignal. www.eSignal.com)
Our last example is on the short side. Figure 8.21 is a daily chart of USD/JPY.
The chart illustrates that USD/JPY made a new 20-day low on October 11 below 109.30. The currency pair then proceeded to make a new two-day high on October 13 of 110.21. Prices then reversed over the next two days to break below the original 20- day low, at which point our sell order at 109.20 (a few pips below the 20-day low)
was triggered. We placed our stop a few pips above the two-day high at 110.30. As the currency moves in our favor, we have two choices: either to take profits by double the amount that we risked, which would be 220 pips in profits, or to use a trailing stop such as a two-bar high. The two-bar profit would have the trade exited at 106.76 on November 2, while the 220-pip profit would have the trade exited at 107.00 on October 25.
CHANNEL STRATEGY
Channel trading is less exotic but nevertheless works very well with currencies.
The primary reason is because currencies rarely spend much time in tight trading range and have the tendency to develop strong trends. By just going through a few charts, traders can see that channels can easily be identified and occur frequently. A common scenario would be channel trading during the Asian session and a breakout in either the London or the U.S. session. There are many instances where economic releases are triggers for a break of the channel. Therefore it is imperative that traders keep on top of economic releases. If a channel has formed, a big U.S. number is expected to be released, and the currency pair is at the top of a channel, the probability of a breakout is high, so traders should be looking to buy the breakouts not fade it.
Channels are created when we draw a trend line and then draw a line that is parallel to the trend line. Most if not all of the price activity of the currency pair should fall between the two channel lines. We will seek to identify situations when the price is trading within a narrow channel, and then trade in the direction of a breakout from the channel. This strategy will be particularly effective when used prior to a fundamental market event such as the release of major economic news, or when used just prior to the open of a major financial market.
Here are the rules for long trades using this technique.
1. First, identify a channel on either an intraday or a daily chart. The price should be contained within a narrow range.
2. Enter long as the price bleaks above the upper channel line.
3. Place a stop just under the upper channel line.
4. Trail your stop higher as the price moves in your favor.
Examples
Let us now examine a few examples. The first is a USD/CAD 15-minute chart shown in Figure 8.22. The total range of the channel is approximately 30 pips. In accordance with our strategy, we place entry orders 10 pips above and below the channel at 1.2395 and 1.2349. The order to go long gets triggered first and almost immediately we place a stop order 10 pips under the upper channel line at 1.2375.
USD/CAD then proceeds to rally and reaches our target of double the range at 1.2455. A trailing stop also could have been used, similar to the ones that we talked about in our risk management section in Chapter 7.
Figure 8.22 USD/CAD Channel Example (Source: eSignal. www.eSignal.com)
The next example, shown in Figure 8.23 is a 30-minute chart of EUR/GBP. The total range between the two lines is 15 pips. In accordance with our strategy, we place entry orders 10 pips above and below the channel at 0.6796 and 0.6763. The order to go long gets triggered first and almost immediately we place a stop order 10 pips under the upper…
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Figure 8.24 EUR/USD Channel Example (Source: eSignal. www.eSignal.com)