the official advocate for personal investing originally...
TRANSCRIPT
Start a T.A. RoutineDo Your
Homework:
By Bryan Dolan
The Official Advocate for Personal Investing Originally published March 2009. SFO magazine.
Whenever I speak at Traders’ Expos, or more frequently during my weekly Market Call
webinar at Forex.com, I’m asked about very basic technical analysis questions. Queries such
as “What chart timeframe is the best to watch?” and “What moving averages work best?” are
fairly typical. These questions come from both experienced traders and relative newcomers,
so it strikes me that a bigger issue exists here than meets the eye.
If I had to pin it down, I suggest that many traders are pursuing an unstructured approach
to technical analysis—looking at certain indicators some of the time, searching for the “right”
moving averages or seeking the best momentum study—to improve trading outcomes. But
that sounds like the perennial search for a technical “silver bullet” that does not exist. It also
reeks of putting the cart (trade strategy) before the horse (technicals), as in “I’m going to
trade the euro/U.S. dollar, what do the technicals say?”
Instead, I propose that a dedicated, systematic routine of technical analysis is a bet-
ter approach to both identifying potential trade opportunities, or setups, and successfully
managing open positions. Though the routine I outline here is centered on foreign exchange
trading, the utility of a routine applies to all markets.
Advantages of a RoutineThe benefits of a routine for technical analysis are multiple. First off, it puts the cart squarely
behind the horse, meaning the objective is to see what the technicals suggest as to potential
trading opportunities rather than selecting a market and using the technicals to justify or
rationalize a trade.
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In many respects, price developments
like a daily close above a key moving aver-
age or a bullish engulfing line on daily close
candlesticks, suggest trading setups in their
own right. Where the fundamentals may be
confused, a technical signal may offer an
otherwise unseen opportunity. Where the
fundamentals are clear (and likely triggered
the key breaks), the technicals confirm and
add conviction. But without a clear routine for
technical analysis, traders may miss signals for
potential trading opportunities.
A regimen of technical analysis also gives
traders greater overall “technical awareness,”
which is the key to staying ahead of the market
and maintaining sanity, generally speaking. For
example, rather than identifying the technical
basis for a breakdown in the dollar/yen (USD/
JPY) after the fact, a regular analysis of USD/JPY
can allow a trader to identify the triggers that
might lead to a break lower before it happens and
possibly suggest a trade setup in the process.
Along with a better technical “feel” for where
a currency pair stands, a thorough techni-
cal regimen is also likely to leave one with a
greater sense of order, even when markets turn
chaotic. Recent high volatility in forex markets
makes this even more important. In December
2008, the euro/U.S. dollar (EUR/USD) sky-
rocketed from below 1.30 to a high just over
1.47 in a matter of days, and many traders were
scrambling to keep up with the move.
But a dedicated routine of technical analy-
sis would have highlighted a number of key
technical points, one of which (200-day moving
average) effectively capped the rebound and
sparked a significant intraday reversal (see
Figure 1). On its own, that spike reversal was
a significant technical signal that a key high
had been reached, suggesting potential short
setups in the days that followed.
Candles and CloudsA dedicated approach to technical analysis also
includes daily candlestick and ichimoku chart
observations, which may reveal potentially sig-
nificant trading opportunities not highlighted
by more traditional approaches. If a trader is
unfamiliar with those approaches, I suggest he
or she study up. Lastly, a regular survey of the
technical landscape allows traders to set price
alerts at key technical points, enabling them to
stay on top of the market even when they are
not in front of their screens. But one cannot set
an alert if the analysis is not done in order to
identify the price level.
The BasicsAs its name suggests, a routine of technical
analysis refers to performing the same types
of analysis on a regular basis. But a routine for
analysis of what? The starting point for de-
veloping a regimen is to define which markets
to analyze regularly—a.k.a. the universe. In
FX, one can follow dozens of pairs, which can
be overwhelming and defeat a key purpose of
a routine, which is to streamline information
gathering, the essence of technical analysis.
For currency traders, build a solid founda-
tion by focusing on the U.S. dollar “major” pairs
(EUR/USD, USD/JPY, sterling/dollar (GBP/
USD), dollar/Swiss (USD/CHF), Aussie/dol-
lar (AUD/USD), New Zealand/dollar (NZD/
USD) and dollar/Canada (USD/CAD)), along
with two key crosses: euro/yen (EUR/JPY) and
euro/sterling (EUR/GBP).
It’s also worth following the ICE U.S. Dollar
Index for an indication of overall U.S. dollar
direction, but note that it is heavily weighted
toward Europe (77.2 percent includes the euro,
pound, Swiss franc and the Swedish krona)
and is frequently an inverted image of EUR/
USD. I’m not suggesting the pairs mentioned
are the only ones to watch, but I find they cover
the bulk of forex market action.
The main idea is to settle on the universe
of currency pairs that one is most active in
trading (or anticipates trading) and to stick
with it. One might embrace the Zen of the yen
and focus primarily on JPY-crosses (e.g., GBP/
JPY, CAD/JPY, AUD/JPY, etc.). A trader might
be a Canadian native and want to focus on all
things Canadian dollar. Traders just need to
be sure to stick with whatever set of currency
pairs they decide to follow.
Take Off the BlindersThe universe of a routine for currency analysis
does not stop with currency pairs. Given the
overlap between currency markets and other
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financial markets, I think it’s crucial to include
other key financial markets in a routine, espe-
cially as intermarket correlations have been
highly pronounced during the past year.
Here, I suggest following the CRB Index for
commodities, the S&P 500 for stocks and the
10-year U.S. Treasury yield for bonds. Due
to the sometimes high correlations between
specific commodities and the commodity cur-
rencies (CAD, AUD and NZD), I also like to in-
clude West Texas Intermediate (WTI) crude oil
futures and spot gold individually. Again, it is
up to the trader to decide which other markets
he or she wants to incorporate into the routine,
some of which may depend on when the person
is actively trading. For example, if one trades
primarily in the U.S. evenings, he or she might
consider the Nikkei as the stock index to watch.
Once a trader has settled on the universe
for analysis, it helps to set up and save chart
pages for each market with standardized set-
tings to maintain the routine. My own prefer-
ences (traders should feel free to incorporate
their own—only they know what works best
for them) are to use candlestick charts with
moving average convergence divergence
(MACD) and average directional index/direc-
tional movement indicator (ADX/DMI) studies
(stacked to provide maximum chart visibility),
overlaid with four simple moving averages (21-,
55-, 100- and 200-periods).
My rationale for these choices is straightfor-
ward enough. Candlesticks provide much more
information visually than any other charting
alternative. I like to filter a momentum indica-
tor (MACD) with a trend indicator (ADX/DMI),
relying on momentum when no trend is evident
and deferring to the trend when one is present.
The idea is to avoid getting flummoxed by an
overbought/oversold momentum reading when
a trending move is unfolding, potentially lead-
ing to a large directional price move that defies
momentum extremes.
Lastly, the four moving averages used are the
most popular in my experience, and it’s always
worth watching what everyone else is. (Why 21
and 55 instead of 20 and 50? Twenty-one and
55 are Fibonacci numbers.)
During the past few years, I have also added
ichimoku charts as an integral component of my
routine. Ichimoku charts, also known as Japa-
nese cloud charts, are mostly one big moving
average/trend identification system. [For more
information, see “Trading With Clouds,” March
2008 by Brian Dolan.] Ichimoku charts are a
separate chart form that identifies four price lev-
els that act as support and resistance, as well as
generates buy and sell signals with crossovers.
Ichimoku levels are based on daily price
moves and do not fluctuate intraday, meaning
one needs only to note the ichimoku levels rela-
tive to price to get any signals they are sending.
Making it RoutineThe first step in implementing a routine for
technical analysis is to undertake multiple
timeframe analysis. Simply put, it means per-
forming the same analysis for each pair in a
few different timeframes. My own preferences
are to focus on daily, four-hour and hourly
charts to get a firm handle on what is happen-
ing technically.
Depending on the trading style, a trader
may want to use shorter timeframes (e.g.,
two hours and 30 minutes), but I recommend
always beginning with a look at daily charts.
Even super-short-term traders who rarely
look at anything longer than a 15-minute
chart will probably want to know if prices
are up against daily trendline resistance that
dates back six months. Daily charts provide
the big picture view and highlight potentially
larger moves than any shorter timeframe. I
also suggest looking at weekly charts at least
once a month to keep a handle on even longer-
term potentialities.
In terms of analyzing each timeframe, begin-
ning with the longest and drilling down to the
shortest, I would suggest the following routine
for each timeframe:
• Pattern recognition: Inspect for key chart
formations, such as double tops/bottoms,
ascending/descending wedges or triangles,
head and shoulders/inverted head and shoul-
ders, and bull/bear flags. Remember, patterns
can appear in any timeframe. When looking
at daily timeframes, study daily candlesticks
for any patterns that may be present.
• Trendline analysis: Draw in trendlines that
capture the essence of the recent price
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direction. If a currency pair has been mov-
ing lower, for instance, a trader will want to
highlight the key resistance lines that keep
the downward move intact. Next, look to
identify likely support levels, which if broken
may lead to further declines. Then ask, if
XYZ support is broken, what’s the next likely
target? If a pair is moving sideways, look to
identify the upper and lower boundaries to
identify where a breakout may occur. Record
these levels for easy reference, but recognize
that trendlines on shorter-term charts will
move over time, depending on their slope.
• Moving average analysis: Record the levels
of daily moving averages as they will not
move during the day. Also note the hourly
moving average levels but be aware they
may move over the course of the day, per-
haps sizably if volatility is high. Moving av-
erages can be significant sources of support
and resistance, and a break is confirmed
when a period closes above/below the mov-
ing average—that is, an hourly moving aver-
age is broken with an hourly close above/
below the average.
• Momentum analysis: Look for overbought/
oversold conditions and make a mental note.
Look for bullish/bearish divergences, cross-
overs and other signs that a directional move
is stalling and potentially reversing.
• Trend analysis: Look at ADX readings to see if
trending conditions are evident in the time-
frames analyzed. Compare with momentum
analysis and where a trend is present (ADX >
25), defer to the trend reading; when no trend
is present (ADX < 20), momentum studies
tend to be more effective. Be alert for peaks
in the ADX, potentially signaling that the
trending move is stalling.
Step By StepIf traders run through these steps for all the
markets in their universe, they are more
likely to spot actionable trading opportuni-
ties than if they randomly focus on individual
markets. The trade setups may not be where
they expect, but that is the whole idea—
scanning the same universe with the same
routine is more likely to identify a technically
based trade setup than concentrating on one
or two markets, which may not be sending
any strong signals.
Timing the RoutineAnother question I frequently encounter is
“When is the best time to perform technical
analysis?” The answer to that is easy—when a
trader is square. When traders are out of the
market, they will see charts and indicators
more clearly and with less bias to any funda-
mental views they may hold.
The idea is to approach a routine of techni-
cal analysis with an open mind—listen to what
the charts are saying. Sometimes they might
not have much to say, but other times they will
speak loudly, and a trader will be there to hear
it because of a routine. Otherwise, the specific
time traders perform their routines depends
on their schedules and trading styles, but
running through a routine before trading is
always recommended.
Watch the FX CloseOne time of day that I like to highlight is the
daily close, which in FX occurs at 5 p.m. ET.
Daily closing levels frequently generate some
of the most powerful technical signals out
there. Why? Because after a full trading day,
markets have digested all manner of news and
data—price movements included—and pro-
nounced a verdict: the daily close.
If a major daily moving average or key
trendline is to be broken, traders will only
know for sure after the daily close. That’s also
when daily candlesticks are finalized (I focus
exclusively on daily candles for signals), po-
tentially presenting a tradable pattern.
It’s also when ichimoku signals are gener-
ated. For example, prices may have tested
higher into the cloud during the day, but if
they fail to close above the cloud base, a rejec-
tion may be signaled (see Figure 2).
In addition to the routine outlined earlier,
I strongly urge traders to incorporate daily
close observations as a regular part of any
routine for technical analysis. And traders
must remember to set aside time on the week-
ends to run through weekly close observa-
tions, which can pack even more information
content than daily closes.
Source: Bloomberg
This reveals a failure (blue circle) of the pound to make a daily close inside the cloud (yellow shaded area), suggesting a rejection lower. Subsequent declines below the kijun line (dark blue line) and tenkan line (green line) confirmed the weakness and kept the focus to the down side.
Figure 2: Daily Ichimoku Chart of Sterling/Dollar
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Wrapping UpMost traders practice some form of technical
analysis as part of their trading game plans, but
they may not be getting as much from it as they
could if they focus only on short-term charts,
one or two indicators or just a few markets.
By adopting a thorough routine for technical
analysis, traders can streamline their efforts
and cover more markets, potentially identifying
more solidly based technical trading setups.
Most important, though, following a rou-
tine puts the technicals squarely out front. If
the technicals are not sending any signals for
a particular market, then there is probably
insufficient cause to be trading there. But if
a market is sending a trading signal, a disci-
plined routine of technical analysis is more
likely to catch it than a less rigorous approach.
By regularly analyzing a fixed universe of
markets with a standardized approach, trad-
ers have a better chance of catching tradable
technical signals when present and avoiding
markets that do not offer such clarity.
Brian Dolan is the chief currency strategist at FOREX.com/
GAIN Capital and a 19-year veteran of the currency markets.
Dolan provides fundamental and technical analysis to
FOREX.com clients and is a frequent commentator for finan-
cial media such as Bloomberg, CNBC, Reuters and Dow
Jones. He authored Currency Trading for Dummies.
Copyright 2011 by Wasendorf & Associates Inc. All rights reserved. No part of this publication may be reproduced or transmitted in any form by any means, electronic or mechanical including posting to another website, photocopying, recording or by any informative storage and retrieval system without the written permission of Wasendorf & Associates Inc.’s President. This article is strictly the opinion and conjecture of its writers and is intended solely for informative and educational purposes and is not to be construed, under any circumstances, by implication or otherwise, as an offer to sell or a solicitation to buy or trade in any commodities or securities herein named. This article is not meant to recommend, promote or in any way imply the effectiveness of any trading system, strategy or approach. Information is obtained from sources believed to be reliable, but is in no way guaranteed. Further, there is no guarantee of any kind that is implied or possible where projections of future conditions are attempted. The publisher is not liable for typographical errors. Commodity futures, securities, options and forex trading involve risk and are not suitable investments for everyone. Any investment should be carefully considered in light of an investor’s personal financial objectives and risk tolerance. The article contained herein may provide hypothetical or simulated performance results. Hypothetical or simu-lated performance results have certain inherent limitations. Unlike an actual performance record, simulated results do not represent actual trading. Also, since the trades have not actually been executed, the results may have over- or undercompensated for the impact, if any, of certain market factors such as the lack of liquidity. Simulated trading programs are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. Further, past performance does not guarantee future results.