Stock traders often add currencies to portfolios, in order to benefit from the incredible opportunities that currency trading can present. While it is true that stocks require a different set of analyses, there is enough in common between the two asset classes that should enable a stock trader to adapt quite easily to currency trading. Although the following method is designed as a swing trade that can be held for many days or weeks, it is also possible to use the tiger trading methodology to hold the position even longer, as long as the trade remains profitable. (To learn more about how currencies are traded Forex: Wading Into The Currency Market.)
TUTORIAL: Analyzing Chart Patterns
Why the Tiger?
It seems that animal traits can be used quite effectively to describe human trader attributes. Let's not forget that bulls can make money, and so can bears, but why the reference to the tiger? A tiger is a prodigious hunter and has the proverbial patience of a cat. It can sit and wait until the odds of a successful hunt are very high. For those traders with similar personality characteristics, trading the way a tiger hunts can be very lucrative.
What Is a Long-Term Chart?
In order to be a tiger trader, investors need to position themselves so that the trade opportunity can best be seen from a distance, so to speak. To get the overview of the market and the way it has been trading, we should always look to the weekly chart. For stock market traders, the weekly chart may be a relatively short-term chart compared with monthly (or even yearly) charts. However, in the forex markets, weekly charts are considered long-term, from a trader's perspective.
What is Special About the Weekly Chart?
A weekly chart in the forex markets is the only time frame that shows a true close. The close is on Friday afternoon at 5pm EST, and the forex markets open again on Sunday at 5pm EST. Daily charts in the forex markets don't really close, although there is a settlement time, which changes depending on which forex market you are trading in. For example, the New York market opens on Sunday at 5pm EST in New York. The following day, the New York closes at 5pm EST for settlement, and just one minute later, the market re-opens and all trading resumes. There is no overnight, because as soon as New York closes, Australia opens. Hence, forex markets trade 24 hours around the clock until Friday at 5pm EST.
Using a weekly chart (Figure 1), we will be able to draw our "lines in the sand," whether these are trendlines, Fibonacci lines, Gann lines, double tops or bottoms, etc. These lines are typically drawn from the weekly high or weekly low points, as well as on the weekly close. This will help to gauge where longer-term traders are focusing. Since the longer-term traders are usually the position traders who are usually interested in "carry trade" opportunities, they tend to take larger positions, and therefore, collectively are quite influential in creating a direction in the market.
Whether reversals often occur at Fibonacci levels are a result of some natural order that the market obeys, or whether the Fibonacci levels have credence because so many traders watch them, and therefore trade off of these levels, really doesn't matter, as long as these levels display some validity.
Get a Big Picture Overview
For a tiger trade, the longer time frame dominates the shorter time frame. In other words, signals from a weekly chart are more pronounced than signals from a daily chart. Prices shown on the shorter time frames can actually oscillate and generate alternate buy or sell signals, even while the longer trend remains intact. However, when the longer time frame shows prices approaching a potential reversal level, we need to switch to the shorter time frame because it becomes a leading indicator as to whether the reversal point shown on the longer time frame is likely to have any traction. (To learn more on weekly charting, check out Weekend Analysis: A Path To Forex Profits.)
Keep it Simple
Then, we draw a chart of the currency pair that we wish to trade, set to a weekly time frame (see Figure 2 below) and then another set to a daily time frame, (Figure 3 below). On both charts, we add a Relative Strength Index (RSI) indicator set to an interval of two periods. In addition, we add three simple moving averages, each being set to 20 periods. We set the first moving average to 20, but calculated on the highs, the second calculated on the lows and the third 20-period moving average on the last or closing price.
We will use the RSI as a filter to determine when to buy or when to sell, and the equilibrium lines will be used as an indication of the trend and how price moves from the trend toward extreme sentiment. Hopefully, the software that you use will allow you to do this. (To see more on charting please check out Charting Your Way To Better Returns.)
Understand the Fundamental Drivers
For example, if we are trading the EUR/USD, we might watch for the comments of Trichet, the current president of the European Central bank (ECB), to understand whether the ECB is likely to raise the interest rates in the Eurozone. If the United States is keeping rates low but there is a possibility that the ECB is hawkish on inflation and could raise interest rates, then we want to be long the euro against the dollar.
A Tiger Personality
Remember the tiger personality: it means the patience of a cat! We need to be prepared to wait until all the "stars" are in alignment, namely the price is at an extreme reversal point, or the trend is pulling back to equilibrium, which will provide an opportunity to take a trade at a better price. If either of these two factors should occur, we can get ready to pounce. (For more on trading like a tiger, read Patience Is A Trader's Virtue.)
Overview of a Tiger Trade
First, let's refer to the weekly chart of the DXY to see if price is approaching a pattern or a trend line, or a Fibonacci support or resistance line. In figure 1 (below), we use the weekly chart of the DXY (Dollar Index) to get an overview of the sentiment towards the dollar. The price is approaching a "double top". Since the DXY or dollar index is made up of six currencies it offers a quick perspective of general dollar strength or weakness.
|Figure 1: Weekly Dollar Index|
|Chart courtesy Wordon Brothers|
Markets Can Overreact
Markets can (and do) overreact because emotional humans overreact. This leads to a straying from the equilibrium point, until some extreme point is reached and then, in time, the pendulum will start to revert to the mean. This staggering back and forth from the center is called volatility, and is what provides the tiger with the opportunity to make a profitable snag. (To read more on how markets are affected, read Volatility's Impact On Market Returns.)
Finding a Weekly Set-Up
By scanning through all the major currencies, we notice that the weekly chart (Figure 2) of the euro-dollar is approaching the 127.6 Fibonacci extension. We could conclude that the coincidence, a double top in the one and a Fibonacci support level in the other, indicates a high-odds opportunity for a EUR/USD trade.
|Figure 2: Weekly EUR/USD|
|Chart courtesy Wordon Brothers|
The Daily Chart - Entry Signal
Once we are happy that there is an opportunity brewing, we can switch down to a daily chart (figure 3, below) of the EUR/USD to observe what happens as the price approaches the 127.6 extension. We also watch to see if the RSI can reach the 5% level, which would indicate a very oversold and extreme sentiment. By listening to the talk in the market, we hear several pundits say that the euro will reach parity with the dollar and the general consensus in the market is to be short the euro.
|Figure 3: Daily EUR/USD|
|Chart courtesy Wordon Brothers|
The Candlestick Chart
At this point, it is also important to watch what happens at the 127 Fibonacci line and to see what kind of candle pattern forms. Usually, a hammer, spinning top or doji would be an indication of changing sentiment by the professional traders.
Stacking the Odds
The combination of the DXY at a double top, the weekly EUR/USD at a 127.6 Fibonacci extension, the RSI at about 5% and a spinning top forming on the daily chart indicates a potential trade (Figure 4, below). An order is placed in the market to go long the EUR/USD if it breaks above the high of the spinning top at 1.2015 and, if executed, a stop loss order is placed at 1.1870.
The risk is 140 pips. For every standard contract of 100,000 the value of a pip is $10. Therefore, the dollar value of the risk is $1,400. This risk should represent no more than 2% of trading capital, which means we should have $70,000 equity in our accounts or otherwise trade smaller, mini contracts instead. (For more on charting, see A Glance at an Equilibrium Chart.)
|Figure 4: Entry Point on Daily EUR/USD Chart|
|Chart courtesy Wordon Brothers|
Looking at Figure 4, the EUR/USD proceeds to 1.3200 before any signs of a real correction or potential change in trend are observed, and the opportunity to stay in the trade or even add to it as price pulls back to the lower lines of the equilibrium channel. The trade would be cut short by a trailing stop below the channel if such a level is reached. Alternatively, a trailing stop could be set to cut the trade by 50% and allow the remaining 50% to remain open as long as the trade remains profitable.
The value of this trade is approximately 1,200 pips, which for a standard contract would be equal to $12,000. The risk-to-reward ratio is 1200/140 or 8.57-times, certainly worthy of a patient tiger. The margin required to take this trade is approximately $1,200. The ROI is 12,000/1,200 or 1000%.
The Bottom Line
Tiger trading is not for those without patience. It is necessary to let the market come to you rather than to chase the market in the fear of missing a trade. If you miss the trade, be consoled; there is always another opportunity. Just sit and wait patiently, but remember the old proverb, "fortune favors the well-prepared mind." (To learn from some of the best investor, check out Financial Wisdom From Three Wise Men.)