Short term trading techniques for the FX market
Given my background as a scalper in
the equities market for eight years, I am often asked if those same
techniques are applicable to the FX market. It is important to define how one
defines scalping. First, recalling my days as a floor/screen based trader of
equities in 90’s the definition was a technique whereby a trader could profit
from very short-term moves in the marketplace by using a combination of 1 &
5-minute charts as well as a keen sense of tape reading. When I made the
transition to the FX markets exclusively back in 2001-02 I was keenly aware that
this type of hyper strategy had 2 shortcomings:
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1. It was not scalable
2. A scalping technique may not be conducive to the FX markets
While point #2 may be open to debate, one cannot argue that short-term
strategies have a finite amount of capital you can deploy at any point in time
without disrupting the market.
So with that in mind, the angle I decided to take on this article was to
illustrate how some of the techniques and indicators used in a scalping strategy
can still be overlaid on to a swing trading approach in order to maximize entry
and exit points. First some assumptions for the forthcoming analysis:
– Trade selection is done using one of or a combination of a 60 & 240-min charts
as well as a daily chart. A weekly chart is used merely as a way to identify
long-term support and resistance areas.
– I will discuss several indicators, mainly stochastics, fibonacci retracements
and extensions, trend-lines and RSI, Elliot Wave analysis
– Trade duration average is several days
– I rely upon not only the G10 pairs but also several crosses
– Risk is defined in advance of each trade and lot size is calculated based on
stop-loss
There are limitations, as with any technical approach that combines a fair
degree of discretion as rigid entry guidelines may prevent a trade from being
executed. However the effectiveness and precision of the entry techniques will
typically avoid costly drawdowns while the trade is playing out.
Here is an ideal example of using a big picture viewpoint/analysis, but drilling
down to a lower time frame in order to pinpoint the entry in an attempt to
execute at a price that will perhaps provide immediate validation.
In this instance, I am anticipating that a re-test of the bull
trend-line will fail, however, the ‘ideal’ scenario is to have the daily
stochastic pointing down in order to have bearish momentum at our back. As you
can see from the daily chart above, this is not the case. However, what if we
could speed up the analysis in terms of drilling down a time frame or two and
essentially forecast the turning of that stochastic lower?
I rely heavily upon on the 60 & 240-minute in order to execute trades while
frequently doing the analysis on the daily chart. Referring to the 240-minute
chart below, it provides an ideal example of using the lower time frame for
execution. Note the following:
– Spinning top suggests a reversal is imminent
– Stochastic cross lower igniting bearish momentum
– Trend-line break (115.53) triggers ideal entry
If there is one question mark on this entry it is that the current trend on the
240-minute chart that is up. Trend is defined by 2 parameters:
1. What is the slope of the 20-period ema over the last half a dozen bars?
2. Are price bars above or below the ema?
Ideally, for shorts, price bars are below a downward sloping moving average and
vice versa for longs.
So now what, where do we take profits? In this case, given
that the trend is up on the time frame that we used for execution there is not
the luxury of letting the trade ride. In this instance, the logical exit points
are seen at either the 50% fib retracement at 115.12 or the swing high at
115.24. These levels are easily achieved.
AUD/NZD Short
This cross has been ‘in play’ this year and continues to be a
cross I have relied upon frequently. In this scenario we have a situation where
the daily chart suggests a possible short, but does not provide all the points
on the checklist for a high probability short.
– Wave 4 completion is confirmed by a stochastic cross lower
and a trend-line break
– Price targets are calculated by a simple fibonacci extension of wave 3 using a
1.25 and 1.50 setting
Regardless of the trade, I always respect the time frame that
the trade was executed on. In this case, the execution was based on analysis of
the 240-minute chart, as a result, exit points also need to be calculated from
the same time frame.
Given that our first target was 1.1740 we still want to give the chance for the
trade to play out, however, given that the trade is in roughly 100 pips in the
money and the stochastic suggest that the selling pressure is waning, it is
prudent to take some of the trade off and adjust stop-loss to either break-even
or some price that suits the traders risk tolerance, a trailing stop is ideal.
NZD/SEK Short
The chart below provides a perfect example of two time frames coming together
that isolate a fantastic short opportunity. In this case, the daily chart is
already confirmed as bearish, now, it is just a matter of isolating the entry
point as a way to avoid the trade going against you while waiting for the
downward trend to resume. Until the 60-minute charts stochastic roll back over
prices are likely to drift higher. The better entry is to wait for pullback into
fibonacci resistance at 5.2450-5.2500 and waiting for bearish momentum to resume
by way of a stochastic cross.
AUD/JPY Long
1. Bear trend-channel is broken
2. Prices fail at swing low at 85.00 and form right shoulder of inverted head &
shoulders pattern
3. A fibonacci retracement of the move higher from 5/23 offers the ‘ideal’ long
entry point for a test to break the neckline
4. Stochastic is expected to pullback; turn higher confirming point number 3
5. If all points above are confirmed the target price has a solid chance of
being hit
All of the above points were met and prices did move right into the target price
at 85.60
Looking Ahead
While it is too early to offer any short-term analysis, the daily chart of USD/JPY
will likely provide traders an ideal short entry for both longer-term and
short-term traders.
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As always, feel free to send me your comments and questions.
Dave Floyd
Aspen Trading Group
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