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TRADING Strategies

Cashing in on short-term
CURRENCY TRENDS
Trends may be rarer than trading ranges, but that
doesn’t mean they can’t be traded. This strategy
uses two time frames to identify the trend, an
overbought-oversold indicator to pinpoint entry and
a trailing stop to protect gains on profitable trades.

BY TIMOTHY O’SULLIVAN

M any technical trading
strategies revolve around
the assumption that mar-
kets will hover within a
given range — and with good rea-
son. Seventy percent of the time
markets will bounce back and forth
market involve the majors.

The strategy uses two charts with differ-

FIGURE 1 LONG TRADE, HOURLY TREND
ent time periods (10-minute and hourly),
along with two technical indicators: a
200-bar moving average and a 14-bar
slow stochastic study (see “Stochastic

between support and resistance lev- With price consistently above the 200-bar moving average, the hourly chart reflects
els, or fluctuate randomly. The rest the prevailing uptrend.
of the time, market behavior is char- Euro/U.S. Dollar (EUR/USD), hourly
acterized by persistent price moves
1.002
— trends — that shatter support and
resistance levels. 0.996
Although these basic probabilities 0.990
work against traders who try to
0.984
exploit trends, the potential rewards
can be worth the risk. It is possible to 0.978
increase your ability to capitalize on 0.972
trends by locating trend signals,
0.966
identifying specific entry points
within the trend and using risk man- 0.960
agement techniques to limit losses. 0.954
200-hour moving average
The following sections will
explain how a trading system based 0.949
on these concepts works especially 0.942
well in the foreign exchange (Forex),
or currency, market, particularly Stochastics (14, 3, 3)
90
with the “major” currencies — the
U.S. dollar, Euro, Japanese yen, 60
British pound, Swiss franc, 30
Canadian dollar and Australian dol- 12:00 3:00 18:00 9:00 0:00 15:00 6:00 21:00 12:00 3:00 18:00 9:00 0:00 15:00 6:00
lar. More than 85 percent of transac- 18 19 20 21 23 24 25 26 27 28
tions in the $1 trillion per day Forex Source: Gain Capital

2 www.activetradermag.com • October 2002 • ACTIVE TRADER

3)] would be shorter-term and more sensitive than a stochastic average on the 10-minute chart. an addition- and the fact that price is within 20 points ally smoothed version of the indicator. %D. is: price is consistently above/below the moving averages on both charts. top left). Once you’ve identified a trend. the fact that price is almost exclusively continued on p. On a decreasing the length of the moving average used to calculate %D.” right). the following exam- Seventy percent of the time markets ples use a trailing stop 25 points from each new top or bottom. average(%K. On the currency quoting and charting conven. Eurocurrency-dollar (EUR/USD) cur- rency pair during the fourth week of minute EUR/USD charts. look for the following where two conditions at the same time on the 10-minute chart: 1) the market is no Ct = the most recent bar’s closing price more than 20 points above (to buy) or 20 points below (to sell) the moving aver. For exam- long position. where the original %D line becomes a of the moving average) and is poised to new “slow” %K line and a three-period average of this line becomes the “slow” turn (because the fast stochastic line is %D line. On the 10-minute chart (Figure 2. the default is five days) stochastic line above 80 (to sell). (For those unfamiliar with time when price is above the 200-period indicates a persistent uptrend. The second line.com 3 . and 2) the cur.3) rency has paused or pulled back (reflect- ed by the higher low stochastic reading Because this basic “fast” stochastic calculation is very volatile. opposite page). five-bar stochastic calculation is the difference between the most recent bar’s Step 1: Identify a trend. support and resistance levels. These conditions indicate: 1) the cur. raise (for a long trade) or lower (for a short trade) the stop to protect profits. The charts in will bounce back and forth between the next section illustrate the application of this strategy in two currency pairs. The formula for this calculation. is simply a three-period moving average of %K: rency is currently in a short-term uptrend or downtrend. is more commonly used. In the using a 20-bar %K and a five-bar moving average for %D [stochastic(20. %K = 100*{(C t-Ln)/(Hn-Ln)} Step 2: Pinpoint entry. A basic refresher. a stochastic using a 10-bar %K and a three-bar moving average for %D [sto- points below the 200-period moving chastic(10. For simplicity’s sake.low of the range) over a particular period.or shorter-term price move- line).5)]. ment and to be less or more sensitive to small price fluctuations by increasing Step 3: Ride the trend. Look for a above the 200-hour moving average June 2002. Stochastic refresher The stochastic oscillator consists of two lines: %K and a moving average of %K called %D. xx. The result hourly charts.” p. and 2) the fast stochastic line cross- es above the slow stochastic line below Hn = the highest price of the most recent n bars 20 (to buy) or crosses below the slow (for a stochastic calculated on daily bars. crossing back above or below the slow The stochastic can be made to reflect longer. Set a trailing or decreasing the number of bars used to calculate %K and/or increasing or stop after the initial trade entry. moves (and remains above) the moving First. moving averages on both charts.activetradermag. As the trade goes in your favor. which is %K. place the initial stop 10 points above this moving aver- age. see “Quoting currencies. compare the hourly and 10. Compare the close and the lowest low of the last five days divided by the difference moving averages on the 10-minute and between the highest high and the lowest low of the last five days. enter a stop-loss order 10 ple. The basic stochastic calculation compares the most recent close to the price range (high of the range . The first example took place in the or fluctuate randomly. A trend is in effect when is multiplied by 100. x ACTIVE TRADER • October 2002 • www. case of a short position. price tions. Ln = the lowest price of the most recent n bars age.) hourly chart (Figure 1.

119.9950 of moving average 0. Although and midnight on June 27.m.6 is then trailed upward as the 120. 10-minute 1. On the 10- Source: Gain Capital continued on p. the down trending USD/JPY traded consistently below the 200-hour minute chart and the stochastic moving average.m. 8.9975 work against traders who try Market stays within 20 points 0. the basic Euro/U.9967 0.S.9925 0. and U.8 when the indicator is below 20. Dollar/Japanese Yen (USD/JPY).4 for an 84-point ($840) gain. The market moves within 20 points of the moving average between 1 p. The entry is finally signaled when the fast stochastic line crosses above the slow line (a sign of renewed upside momentum) when the indicator is below 20 near 8 p.6 Figures 3 and 4 illustrate a Stochastics (14.6 crosses above the slow stochastic 200-hour moving average 124.9850 Stochastic crosses below 20 0. 3.9868). 40 5:40 9:10 13:10 17:10 20:30 23:50 3:10 6:30 9:50 13:10 17:00 20:20 23:40 3:00 6:20 6/26 6/27 6/28 average in the last third of the Source: Gain Capital chart. The 120.9875 trends.5152. HOURLY TREND moving average on the 10- On June 27. 117. so the stop scaled up to . 77. bottom left) 30 shows price was trading well 14:00 10:00 6:00 2:00 22:00 18:00 14:00 10:00 6:00 2:00 22:00 18:00 14:00 10:00 6:00 below the 200-bar moving aver- 12 13 14 16 17 18 19 20 21 23 24 25 26 27 28 age after June 21. x 4 www.4 requirements.9775 80 worth the risk.9825 potential 0.8996 similar example in the dollar-yen 60 rate (USD/JPY).activetradermag. hourly midnight on June 27 meets these 126. lines cross.0 EUR/USD tops out at . A long position is entered at .9883 0.0000 probabilities Stop out @ 0. 3) 72.m.0424 0.9967. 3. The range between 1 p..m.8 market makes new peaks.9858 (10 122. The next step is to pin- point the entry zone — when the market is within 20 points of the FIGURE 3 SHORT TRADE.9900 to exploit Buy entry @ 0. the 0. with an accompa- 123.9883 124.6808. FIGURE 2 LONG TRADE. The entry point occurs when the fast stochastic 125. The stop 121. 10-MINUTE TREND Price is also above the 200-bar moving average in the final third of the 10-minute chart.2 where the position was closed 118. The hourly chart (Figure 3.9800 rewards can be Stochastics (14.S. 3) 11.0 around 8 p.4 points below the 200-bar moving average value of .com • October 2002 • ACTIVE TRADER . Dollar (EUR/USD).9992.2 nying stop-loss at .

S. you might see a quote such as GBP/USD 1. it means the dollar has appreciated in value and the other currency has weakened.75 at 118. When you’re equipped with a system Stochastics (14.75 trade.4366 U. it’s real- ly quite simple if you remember two things: 1) The first currency listed first is the base currency and 2) the value of the base currency is always 1. For example. dollar.58 (25 points off the 118. A shortcrossed below the slow stochastic line on June 27. meaning that one British pound equals 1. In this case.75 but it is also applicable to others. the Australian dollar (AUS) and the European currency unit.m. In every trade involving the U. price was within 20 points of the 119.Ý 30 6:30 10:00 13:20 17:20 20:40 0:003:20 6:40 10:00 13:20 17:10 20:30 23:50 3:10 6:30 For information on the author see p. 30.00 works well in the Forex market. A quote of GBP/CHF 2. if you see a quote of USD/CAD 1. at when the indicator was above 80.4366.m.4577 Swiss francs. indicating a sell opportunity. Source: Gain Capital Quoting currencies B ecause currencies are quoted in a different manner than equities.S. with three exceptions — the British pound (GBP).57 Each step of the system helps iden- 119. Euro or Australian dollar. dollar are called cross rates. 5 www. stop down as the market contin- U. reading a foreign exchange quote may seem a bit confusing at first. After trailing the — signaling a short trade.01 shows that one U. 119.58 the freedom to experiment with different chart intervals. that means that one U. Whenever the U. price fell Also. Sell entry @ 119.33 low).01 Japanese yen.minute chart (Figure 4.9156.S. you can wait for the rest of the market to follow.25 can be made. However. moving average at this point. 6/26 6/27 6/28 xx.S.01. 3) 28. A lower quote means the base currency is weakening. Likewise. This model also gives you Stop out @ 118. 10-MINUTE TREND stop-loss order at 119. a rising quote means a weakening dollar. the dollar is stronger because it will now buy more yen than before. dollar is not the base rate. dollars to equal one pound. Dollar/Japanese Yen (USD/JPY). The trade was protected with a FIGURE 4 SHORT TRADE.0101 that can help you catch the trend 90 60 early. — while price was below (but within 20 points of) the 200-bar moving average began to decline. but the premise is the same. If the USD/JPY quote we previously mentioned increases to 123.4577 signifies that one British pound is equal to 2. If at any point one of the criteria is not met. dollar is the base unit and a currency quote goes up.00 instantly know not to make a Stochastic crosses above 80 118. dollar is equal to 122.S.50 tify areas where effective trades 119. that increases the value of the base currency. dollar is equal to 1. profits were taken 120.S.50 Market stays within 20 points 120. In other words. 3. as it now takes more U. if a currency quote goes higher. for a gain of 99 points. 10-minute ued to decline. when USD/JPY 5 p.S.com • October 2002 • ACTIVE TRADER .S.54825 Canadian dollars.25 of moving average This short-term trading method 120.S. or Euro (EUR). 120. below). the dollar will be the base currency. a stochastic crossover (above 80) occurred around the following day. In these cases.54825. USD/JPY 122.86.57 when the fast stochastic line below the moving average after 10 a. trade was opened around 5 p. in the three instances where the U. you’ll 119. However. dollars. Trades that do not involve the U. the stop remained intact until On the 10-minute USD/JPY chart.activetradermag.m.