How to Read a Chart & Act Effectively

Introduction

This is a guide that tells you, in simple understandable language, how to choose the right charts, read them correctly, and act effectively in the market from what you see on them. Probably most of you have taken a course or studied the use of charts in the past. This should add to that knowledge.

Recommendation

There are several good charting packages available free. Netdania is what I use.

Using charts effectively

The default number of periods on these charts is 300. This is a good starting point;

• Hourly chart that’s about 12 days of data.
• 15 minute chart its 3 days of data.
• 5-minute chart it’s slightly more than 24 hours of data.

You can create multiple "tabs" or "layouts" so that it’s easy to quickly switch between charts or sets of charts.

What to look at first

1. Glance at hourly chart to see the big picture. Note significant support and resistance levels within 2% of today’s opening rate.

2. Study the 15 minute chart in great detail noting the following:

• Prevailing trend
• Current price in relation to the 60 period simple moving average.
• High and low since GMT 00:00
• Tops and bottoms during full 3 day time period.

How to use the information gathered so far

1. Determine the big picture (for intraday trading).

Glancing at the hourly chart will give you the big picture – up or down. If it’s not clear immediately then you’re in a trading range. Lets assume the trend is down.

2. Determine if the 15 minute chart confirms the downtrend indicated by big picture:

Current price on 15-minute chart should be below 60 period moving average and the moving average line should be sloping down. If this is so then you have established the direction of the prevailing trend to be down.

There are always two trends – a prevailing (major) trend and a minor trend. The minor trend is a reversal of the main trend, which lasts for a short period of time. Minor trends are clearly spotted on 5-minute charts.

3. Determine the current trend (major or minor) from the 5 minute chart:

Current price on 5-minute chart is below 60 period moving average and the moving average line is sloping downward – major trend.

Current price on 5-minute chart is above 60 period moving average and the moving average line is sloping upward – minor trend.

How to trade the information gathered so far

At this point you know the following:

• Direction of the prevailing trend.
• Whether we are currently trading in the direction of the prevailing (major) trend or experiencing a minor trend (reaction to major trend).

Possible trade scenarios:

1) Lets assume prevailing (major) trend is down and we are in a minor up-trend. Strategy would be to sell when the current price on 5-minute chart falls below the 60 period moving average and the 60 period moving average line is sloping downward. Why? Because the prevailing trend is reasserting itself and the next move is likely to be down. Is there more we can do? Yes. Look for further confirmation. For example, if the minor trend had stalled for a while and the lows of the past half hour or hour are very close to the 5 minute moving average then selling just below the lows of the past half hour is a better place to enter the market then just below the moving average line.

2) Lets assume prevailing (major) trend is down and 5-minute chart confirms downtrend. Strategy would be to wait for a minor (up trend) trend to appear and reverse before entering the market. The reason for this is that the move is too “mature” at this point and a correction is likely. Since you trade with tight stops you will be stopped out on a reaction. Exception: If market trades through today’s low and/ or low of past three days (these levels will be apparent on the 15 minute chart) further quick downward price action is likely and a short position would be correct.

3) A better strategy assuming prevailing trend down, 5-minute chart down, and just above days lows is to BUY with a tight stop below the day’s low. Your risk is limited and defined and the technical condition (overdone?) is in your favor. Confirmation would be if today’s low was a bit higher than yesterday’s low and the price action indicated a very short-term trading range (1 minute chart) just above today’s low. The thinking here is that buyers are not waiting for a break of today’s or yesterday’s low to buy cheaper; they are concerned they may not see the level.

4) Generally speaking, the safest place to buy is after a sustained significant decline when the bottoms are getting higher. Preferably these bottoms will be hours apart. By the third or forth higher bottom it is clear a bottom is in place and an up-move is coming. As in the example above your risk is limited and defined – a low lower than the last low.

5) The reverse is true in major up-trends.

Other chart ideas

• There are always two trends to consider – a major trend and a minor trend. The minor trend is a reversal of the major trend, which generally lasts for a short period of time.
• Buying above old tops and selling below old bottoms can be excellent entry levels; assuming the move is not overly mature and a nearby reaction unlikely.
• When a strong up move is occurring the market should make both higher tops and higher bottoms. The reverse is true for down moves- lower bottoms and lower tops.
• Reactions (minor reversals) are smaller when a strong move is occurring. As the reactions begin to increase that is a clear warning signal that the move is losing momentum. When the last reaction exceeds the prior reaction you can assume the trend has changed, at least temporarily.
• Higher bottoms always indicate strength, and an up move usually starts from the third or fourth higher bottom. Reverse this rule in a rising market; lower tops…
• You will always make the most money by following the major trend although to say you will never trade against the trend means that you will miss a lot of opportunities to make big profits. The rule is: When you are trading against the trend wait until you have a definite indication of a selling or buying point near the top or bottom, where you can place a close stop loss order (risk small amount of capital). The profit target can be a short-term gain to nearby resistance or more.
• Consider the normal or average daily range, average price change from open to high and average price change from open to low, in determining your intra-day price targets.
• Do not overlook the fact that it requires time for a market to get ready at the bottom before it advances and for selling pressure to work it’s way through at top before a decline. Smaller loses and sideways trading are a sign the trend may be waning in a downtrend. Smaller gains and sideways trading in an up trend.
• Fourth time at bottom or top is crucial; next phase of move will soon become clear… be ready.
• Oftentimes, when an important support or resistance level is broken a quick move occurs followed by a reaction back to or slightly above support or below resistance. This is a great opportunity to play the break on the “rebound”. Your stop can be super tight. For example, EURUSD important resistance 1.0840 is broken and a quick move to 1.0860, followed by a decline to 1.0835. Buy with a 1.0820 stop. The move back down is natural and takes nothing away from the importance of the breakout. However, EURUSD should not decline significantly below the breakout (breakout 1.0840; EURUSD should not go below 1.0825.
• After a prolonged up move when a top has been made there is usually a trading range, followed by a sharp decline. After that, a secondary reaction back near the old highs often occurs. This is because the market gets ahead of itself and a short squeeze occurs. Selling near the old top with a stop above the old top is the safest place to sell.
• The third lower top is also a great place to sell.
• The same is true in reverse for down moves.
• Be careful not to buy near top or sell near bottom within trading ranges. Wait for breakaway (huge profit potential) or play the range.
• Whether the market is very active or in a trading range, all indications are more accurate and trustworthier when the market is actively trading.

Limitations of charts

Scheduled economic announcements that are complete surprises render nearby short-term support and resistance levels meaningless because the basis (all available information) has changed significantly, requiring a price adjustment to reflect the new information. Other support and resistance levels within the normal daily trading range remain valid. For example, on Friday the unemployment number missed the mark by roughly 120,000 jobs. That’s a huge disparity and rendered all nearby resistance levels in the EURUSD meaningless. However, resistance level 200 points or more from the day’s opening were still meaningful because they represented resistance to a big up move on a given day.

Unscheduled or unexpected statements by government officials may render all charts points on a short-term chart meaningless, depending upon the severity of what was said or implied. For example, when Treasury Secretary John Snow hinted that the U.S. had abandoned its strong U.S. dollar policy.

Common Sense Guidelines for the Average Trader

Look for a reputable broker

• Ability to trade effectively depends on consistent spreads and ample liquidity
• Anyone can establish a position
• Ability to close out a position at a fair market price is more important

Live to trade another day

• Apply prudent money management skills
• Avoid using excessive leverage that puts your investment capital at risk
• Always trade with a stop!

Don’t trade emotionally, stick to your plan and maintain discipline

• Establish a trading plan before initiating a trade
• Set reasonable risk/reward parameters
• Don’t override your stops for emotional reasons
• Don’t react to price action – means don’t buy just because it looks cheap or sell because it looks too high, Have supporting evidence to back up your trade

Don’t punt

• Don't punt( Punting is trading for trading sake without a view)

Don’t leave stops at obvious levels such as “big figures” (e.g. eur/usd 1.20, usd/jpy 110)

• i.e. JUBBS stops = stops at obvious levels and thus are more likely triggered

Don’t add to a losing position in unless it is part of a strategy to scale into a position

• In other words, don’t double up in the hope of recouping losses unless it is part of a broader trading strategy

Trading with and against the trend

• When trading with a trend, consider the use of trailing stops.
• When trading against the trend, be disciplined taking profits and don’t hold out for the last pip

Treat trading as a continuum

• Don’t base success on one trade
• Avoid emotional highs or lows on individual trades
• Consistency should be an objective

Forex trading is multi-currency

• Watch crosses as they are key influences on spot trading
• Crosses are one currency vs. another, such as eur/jpy (euro vs. jpy) or eur/gbp (eur vs. gbp)
• Crosses can be used as clues for direction for spot currencies even if you are not trading them

Be cognizant of what news is coming out each day so you don’t get blindsided

• Be cognizant of what news is coming out each day so you don’t get blindsided
• Beware of trading just ahead of an economic number and be wary of volatility following key releases

Beware of illiquid markets

• Beware of illiquid markets
• Adjust strategies during holiday or pre-holiday periods to take into account thin liquidity
• Beware of central bank intervention in illiquid markets

Essential Elements of a Successful Trader

Courage Under Stressful Conditions When the Outcome is Uncertain

All the foreign exchange trading knowledge in the world is not going to help, unless you have the nerve to buy and sell currencies and put your money at risk. As with the lottery “You gotta be in it to win it”. Trust me when I say that the simple task of hitting the buy or sell key is extremely difficult to do when your own real money is put at risk.

You will feel anxiety, even fear. Here lies the moment of truth. Do you have the courage to be afraid and act anyway? When a fireman runs into a burning building I assume he is afraid but he does it anyway and achieves the desired result. Unless you can overcome or accept your fear and do it anyway, you will not be a successful trader.

However, once you learn to control your fear, it gets easier and easier and in time there is no fear. The opposite reaction can become an issue – you’re overconfident and not focused enough on the risk you're taking.

Both the inability to initiate a trade, or close a losing trade can create serious psychological issues for a trader going forward. By calling attention to these potential stumbling blocks beforehand, you can properly prepare prior to your first real trade and develop good trading habits from day one.

Start by analyzing yourself. Are you the type of person that can control their emotions and flawlessly execute trades, oftentimes under extremely stressful conditions? Are you the type of person who’s overconfident and prone to take more risk than they should? Before your first real trade you need to look inside yourself and get the answers. We can correct any deficiencies before they result in paralysis (not pulling the trigger) or a huge loss (overconfidence). A huge loss can prematurely end your trading career, or prolong your success until you can raise additional capital.

The difficulty doesn’t end with “pulling the trigger”. In fact what comes next is equally or perhaps more difficult. Once you are in the trade the next hurdle is staying in the trade. When trading foreign exchange you exit the trade as soon as possible after entry when it is not working. Most people who have been successful in non-trading ventures find this concept difficult to implement.

For example, real estate tycoons make their fortune riding out the bad times and selling during the boom periods. The problem with trying to adapt a 'hold on until it comes back' strategy in foreign exchange is that most of the time the currencies are in long-term persistent, directional trends and your equity will be wiped out before the currency comes back.

The other side of the coin is staying in a trade that is working. The most common pitfall is closing out a winning position without a valid reason. Once again, fear is the culprit. Your subconscious demons will be scaring you non-stop with questions like “what if news comes out and you wind up with a loss”. The reality is if news comes out in a currency that is going up, the news has a higher probability of being positive than negative (more on why that is so in a later article).

So your fear is just a baseless annoyance. Don’t try and fight the fear. Accept it. Have a laugh about it and then move on to the task at hand, which is determining an exit strategy based on actual price movement. As Garth says in Waynesworld “Live in the now man”. Worrying about what could be is irrational. Studying your chart and determining an objective exit point is reality based and rational.

Another common pitfall is closing a winning position because you are bored with it; its not moving. In Football, after a star running back breaks free for a 50-yard gain, he comes out of the game temporarily for a breather. When he reenters the game he is a serious threat to gain more yards – this is indisputable. So when your position takes a breather after a winning move, the next likely event is further gains – so why close it?

If you can be courageous under fire and strategically patient, foreign exchange trading may be for you. If you’re a natural gunslinger and reckless you will need to tone your act down a notch or two and we can help you make the necessary adjustments. If putting your money at risk makes you a nervous wreck its because you lack the knowledge base to be confident in your decision making.

Patience to Gain Knowledge through Study and Focus

Many new traders believe all you need to profitably trade foreign currencies are charts, technical indicators and a small bankroll. Most of them blow up (lose all their money) within a few weeks or months; some are initially successful and it takes as long as a year before they blow up. A tiny minority with good money management skills, patience, and a market niche go on to be successful traders. Armed with charts, technical indicators, and a small bankroll, the chance of succeeding is probably 500 to 1.

To increase your chances of success to near certainty requires knowledge; acquiring knowledge takes hard work, study, dedication and focus. Compile your knowledge base without taking any shortcuts, thereby assuring a solid foundation to build upon.