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trade secrets candlesticks/lower volatility. Conversely, after a smaller candlestick/ low volatility period, look for a breakout to larger candlesticks/high volatility, as neither type of price action continues indefinitely. The key is determining which way the breakout will occur. If you put current market action into the context of overall market action – proximity to prior highs or lows, relationship to historical values, position in a trend, and other reference points – you should be able to get some clues about the likely breakout direction. In this case, the smaller-range period included a hammer, doji and several spinning top candlesticks. All suggest some market uncertainty and indicate that the momentum from the previous trend is drying up. The moving average crossover to the upside and the big white bullish engulfing candlestick confirmed it. A couple of harami candlesticks (inside days to Westerners) followed as the uptrend signaled by the predicted 10-day moving average began to move out of its starting blocks. A logical point for a buy stop might have been above the high of the bullish engulfing candlestick, low enough to get an early entry into a longer-term uptrend if it developed but high enough to reduce the chances for getting caught in another choppy period. 9 – After a nice runup, including two big bullish white candles, the market starts to run out of steam. A shooting star – a candlestick that reaches a new high and then fades, leaving a long upper shadow – and several black candlesticks suggest the move might be over or at least weakening, a clue to tighten protective sell stops. In addition, for the trader keeping an eye on the bigger picture, the high at Candlestick 9 is approaching the previous high before Candlestick 7 several months earlier, which could become a resistance zone that may be difficult to penetrate. 10 – The predicted 10-day moving average turns down several days before the actual 10-day moving average and results in another mov- 84 F o rex Tra di ng Usi ng Inte rmar ket Analysis ing average crossover sell signal on a bearish black candlestick. As before, a nervous, risk-adverse trader might have had a sell stop below the low of Candlestick 10 to protect profits. However, for a new short position, it usually is not a good idea to anticipate a signal but is better to wait for the crossover signal to become evident before entering a trade. That means you may have to sacrifice some potential profit, assuming your signaled move develops, but it reduces the chances of being caught in a costly whipsaw trade if the new trend does not materialize. Of course, you can use the predicted 5-day moving average to get an earlier signal, or as you watch a potential turn shaping up, you may decide to enter a position near the end of the day if you expect that the close will result in a crossover signal on that day. 11 – A succession of black candlesticks turns a short position into a profitable trade quickly. In candlestick analysis, this pattern is known as eight or ten records down, but the criteria for the number of candlesticks varies. In this case, there are only seven black candlesticks, culminating in an interesting final candlestick bottom. On the final day of the downtrend, the market opens near the previous close, rallies above the highs of the two previous days and then collapses to close near the low of the day. At this point, the situation looked exceedingly bearish. As I mentioned before, no market moves only in one direction or with such velocity forever. First, after an extended, rapid move like this, the market is probably oversold and due for at least a pause or bounce. Second, the slide took prices close to the lows established a month earlier, a strong support zone for starting a recovery in the opposite direction. After a couple of harami candlesticks, the market had a breakout day to the upside with a big white bullish candlestick, reaffirmed by strong followup action over the next few days. A potential buy stop 85 trade secrets might have been placed above the high of the erratic last day of the downtrend (horizontal line) to protect profits from the short position. The moving average crossover signal to establish a new long position occurred a couple of days later, still in time to jump on the unfolding uptrend but with a caution sign as the market approached likely resistance from the previous highs. No Magic in Analysis Remember, in every case you should be going with the market flow and not trying to force a position just because you have a moving average crossover and/or a bullish or bearish candlestick chart pattern. There is no one magic bullet or Holy Grail that will assure your trading success. I have previously emphasized intermarket analysis using predicted moving averages because forex markets are especially influenced by intermarket relationships and because forecasted moving averages do exactly what an effective technical indicator is supposed to do: help you identify the onset of a trend in its beginning stages so you can get on board early and then tell you when to get out before there is a subsequent trend reversal. Beyond the effort to develop leading indicators that can provide more accurate market forecasting, I also recommend using multiple confirming indicators in conjunction with each other. In a broader sense I believe that the next major frontier in the effort to expand the scope of market analysis will be to address the challenge of amalgamating single-market data, intermarket data, and fundamental data on global forex markets as well as futures markets into one coherent and quantitative framework that can be computerized and automated. I refer to this comprehensive analytic framework as Synergistic Market Analysis, which I will talk about a little bit more in the next chapter. 86 8 Wave of the Future: Synergistic Market Analysis When I began trading in the early 1970s, there were no stock indexes futures, no eurodollar futures, and no options on futures of any kind. Futures on currencies, gold, interest rates, energy, and options on stocks were all still in their infancy. There was no electronic trading and there were no personal computers to analyze the markets that I was actively trading. The trading world has evolved considerably since then, offering many new markets to trade, especially in the financial arena; lots of different trading instruments; lots of trading software, and a global marketplace that features electronic trading around the clock. It is difficult to imagine that the next twenty-five years could offer as many trading innovations as those of the last twenty-five years. Whatever the future holds, one of the most promising and lucrative trading areas is likely to be the forex market, which is so responsive 87 trade secrets to global economic shifts and geopolitical tensions. Years ago the forex market was limited to banks and financial institutions; individual traders were not part of the picture. Then came the trading prowess of George Soros and other currency speculators who were credited with bringing down the British pound in 1993, the Asian financial crisis in 1997, the launch of the euro in 1999, and other events that brought increased attention to the forex markets, both for speculation and as a means for knowledgeable traders to protect or hedge themselves against adverse changes in currency values. The introduction of the Internet in the mid-1990s gave forex trading a big boost as it made it possible for individual traders to get information and to trade on a level playing field with any trader of any size any place in the world at almost any time of the day or night. As a result, numerous cash forex firms popped up in the late 1990s and early 2000s to accommodate this exploding interest in forex trading, making forex trading available to almost any pocketbook. Electronic forex trading volume has skyrocketed, and the growth in trading forex options promises to be just as dramatic in the next few years as exchanges facilitate that type of trading. The global war on terrorism and other geopolitical, economic and hurricaneomic shocks and events will undoubtedly keep forex markets at the center of the global financial marketplace. The growing influence of China and other Asian markets on the global economy will affect many markets, the forex market foremost among them. With unprecedented trading opportunities provided by the forex market, what the individual trader needs in today’s world of speedy telecommunications and sophisticated trading techniques is what I call Synergistic Market Analysis, the synthesis of technical, intermarket and fundamental approaches. 88 F o rex Tra di ng Usi ng Inte rmar ket Analysis Intermarket Analysis No country, no currency, no economy, and no market is isolated in today’s global economy. Looking at one market means looking at a number of related markets to get the full story about the market forces driving any one market. With forex, that obviously means other currencies, but it also means interest rates, equities markets, and commodities, particularly international markets such as gold and oil. Single-market analysis just is not sufficient anymore. Accurate, Reliable Market Forecasting The trader who wants to have an edge in today’s trading environment needs to look ahead, using techniques and tools such as predicted moving averages that do not lag behind the market but have the ability to anticipate what is likely to happen to price and trend direction in the near future. Because of their trending tendencies, forex markets are especially good candidates for such market forecasting. Failure to incorporate leading indicators and information on related markets into trading strategies puts traders at a great disadvantage in competing with other more sophisticated traders, including professionals who make their livelihood trading forex markets. Neural networks are not only well-suited to analyzing these markets from both a single-market and intermarket perspective but can also incorporate fundamental data as inputs. By using the computational modeling capabilities of neural networks in a structured framework that synthesizes these three approaches and integrates seemingly disparate technical, intermarket, and fundamental data, quantitative trend and market forecasting will continue to be at the cutting edge of financial market analysis in the early decades of the twenty-first century. Even hurricaneomic data can be incorporated into forecasting 89 trade secrets models. Literally any data that may have a bearing on financial markets can be used to determine its relevance to market forecasting. Trading Education Many people get into trading with only a vague notion about how to analyze markets, how to trade them successfully, how to assess risk/ return in trading, and many other factors that trading involves. With today’s more volatile and erratic markets, education and information are even more important for successful trading in the future, and traders need to go to web sites such as www.TradingEducation.com for valuable assistance and free information on trading (see also the list of important web sites on page 97). Additional Factors Affecting Success Even if traders take the Synergistic Market Analysis approach, myriad additional factors can affect their chances for trading success. These include mass psychology, judgment, trading experience, risk propensity, fear, greed, and amount of risk capital available. It is probably not possible to predict the trend direction of financial markets with more than perhaps 80% accuracy, due to randomness and unpredictable events, as well as the difficulty of developing effective forecasting tools. I am, nevertheless, determined to continue my research to push the forecast accuracy envelope as far as it will go; this has been my intellectual passion for the past several decades and continues to excite me. Fortunately, now, I am no longer a one-man research shop since forming the Predictive Technologies Group years ago, which is comprised of a team of analysts, researchers, and programmers, including Ph.D.s who can read books on neural networks as light bedtime reading. 90 F o rex Tra di ng Usi ng Inte rmar ket Analysis I hope that this book will help traders become more aware of the implications that the globalization of the financial markets has on forex trading. By broadening their perspective to include intermarket analysis and various forecasting techniques that have been outlined in this book, I am confident that traders will be able to improve their trading performance by gaining more self-confidence to make better trading decisions, whether trading only the forex market or also trading equities, options, or futures. 91 Trading TRADING Resource RESOURCE guide GUIDE