Forex Price break

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Once prices break out of a wedge, the expectation is that, at a minimum, they will retrace the distance to the point that initiated the wedge. In a falling wedge, the up move may be expected to take prices back to at least the uppermost point in the wedge. Similarly, in a rising wedge, the down move may be expected to take out the low point that first started the wedge formation. Care must be taken to ensure that a breakout from a wedge occurs on heavy volume. This is particularly important in the case of a price breakout on the upside out of a falling wedge.

However, the rigidity of the initial risk estimates does not imply that the initial stop-loss price ought never to be moved in response to favorable price movements. On the contrary, if prices move as anticipated, the original stop-loss price should be moved in the direction of the move, locking in all or a part of the unrealized profits. Let us illustrate this with the help of a hypothetical example.
Assume for a moment that gold futures are trading at $400 an ounce. A trader who is bullish on gold anticipates prices will test $415 an ounce in the near future, with a possible correction to $395 on the way up. She figures that she will be wrong if gold futures close below $395 an ounce. Accordingly, she buys a contract of gold futures at $400 an ounce with a sell stop at $395. The estimated reward and risk on this trade are graphically displayed.




They are a single-focus company concentrating only on developing a technology that will keep cells alive forever--a fountain of youth, if you will. They're years away from perfecting the technology, let alone getting any type of approval. I think if anyone has a shot at succeeding, they do. However, I'm not going to bet the farm on the company. If I buy shares, I think there's a very good chance that they will go to zero--and I'm willing to live with that. Therefore, I would only take a small position. I think the risk to reward is tremendous. I'm not looking for a small gain in these small, single-focus companies--I'm looking for a homerun.

Every chance I get, I follow the markets. However, I work out of two hospitals, I'm writing a book on surgery and spend many nights researching medical technology for TRADEHARD and my own personal investments. I know that due to time constraints, it's not feasible for me to be an active trader. Therefore, I take long-term positions based on sound fundamental research. This approach has worked quite well for me.

Distance Prices in Forex

The distance prices may be expected to move once a breakout occurs from a triangle is a function of the size of the triangle pattern. For a symmetrical triangle, the maximum vertical distance between the two converging boundary lines represents the distance prices should move once they break out of the triangle.

The farther out prices drift into the apex of the triangle without bursting through the boundaries, the less powerful the triangle formation. The minimum measuring objective just stated will ensue with the highest probability if prices break out decisively at a point before three-quarters of the horizontal distance from the left-hand corner of the triangle to the apex.




The same measuring rule is applicable in the case of a right-angle triangle. However, an alternative method of arriving at measuring objectives is possible, and perhaps more convenient, in the case of rightangle triangles. Assuming we have an ascending right-angle triangle, draw a line sloping upward parallel to the bottom boundary from the top of the first rally that initiated the pattern. This line slopes upward to the right, forming an upward-sloping parallelogram. At a minimum, prices may be expected to climb until they reach the uppermost corner of the parallelogram.

In the case of a descending right-angle triangle, draw a line parallel to the top boundary from the bottom of the first dip. This line slopes downward to the right, forming a downward-sloping parallelogram. Prices may be expected to drop until they reach the lowermost corner of the parallelogram.

WEDGES

A wedge is yet another continuation pattern in which price fluctuations are confined within a pair of converging lines. What distinguishes a wedge from a triangle is that both boundary lines of a wedge slope up or down together, without being strictly parallel. In the case of a triangle, it may be recalled that if one boundary line were upward-sloping, the other would necessarily be flat or downward-sloping. In the case of a rising wedge, both boundary lines slope upward from left to right, but for the two lines to converge the lower line must necessarily be steeper than the upper line. In the case of a falling wedge,the two boundary lines slant downward from left to right, but the upper boundary line is steeper than the lower line.

A wedge normally takes between two and four weeks to form, during which time volume is gradually diminishing. Typically, a rising wedge is a bearish sign, particularly if it develops in a falling market. Conversely, a falling wedge is bullish, particularly if it develops in a rising market.

Symmetrical And Right-Angle Triangles

A symmetrical triangle is formed by a series of price reversals, each of which is smaller than its predecessor. For a legitimate symmetrical triangle formation, we need to observe four reversals of the minor trend: two at the top and two at the bottom. Each minor top is lower than the top formed by the preceding rally, and each minor bottom is higher than the preceding bottom. Consequently, we have a downward-sloping trend line connecting the minor tops and an upward sloping trend line connecting the minor bottoms. The two lines intersect at the apex of the triangle. Owing to its shape, this pattern is also referred to as a “coil.” Decreasing volume characterizes the formation of a triangle, as if to affirm that the market is not clear about its future course.

Normally, a triangle represents a continuation pattern. In exceptional circumstances, it could represent a reversal pattern. While a continuation breakout in the direction of the existing trend is most likely, a reversal against the trend is possible. Consequently, avoid outguessing the market by initiating a trade in the direction of the trend until price action confirms a continuation of the trend by penetrating through the boundary line encompassing the triangle. Ideally, such a penetration should occur on heavy volume.

A right-angle triangle is formed when one of the boundary lines connecting the two minor peaks or valleys is flat or almost horizontal, while the other line slants towards it. If the top of the triangle is horizontal and the bottom converges upward to form an apex with the horizontal top, we have an ascending right-angle triangle, suggesting bullishness in the market. If the bottom is horizontal and the top of the triangle slants down to meet it at the apex, the triangle is a descending right-angle triangle, suggesting bearishness in the market.

Right-angle triangles are similar to symmetrical triangles but are simpler to trade, in that they do not keep the trader guessing about their intentions as do symmetrical triangles. Prices can be expected to ascend descend out of a descending right-angle triangle.

Minimum Measuring Objective

In the case of a double top, it is reasonable to expect that the decline will continue at least as far below the imaginary support line connecting the two tops as the distance from the higher of the twin peaks to the support line. Therefore, the greater the distance from peak to valley, the greater the potential for the impending reversal. Similarly, in the case of a double bottom, it is safe to assume that the upswing will continue at least as far up from the imaginary resistance line connecting the two bottoms as the height from the lower of the double bottoms to the resistance line. Once this minimum objective has been met, the
trader might want to set a tight protective stop to lock in a significant portion of the unrealized profits.

Estimated Risk

The imaginary line drawn as a tangent to the valley connecting two tops serves as a reliable support level. Similarly, the tangent to the peak connecting two bottoms serves as a reliable resistance level. Accordingly, a trader might want to set a stop-loss order just above the support level, in case of a double top, or just below the resistance level, in case of a double bottom. The goal is to avoid falling victim to minor retrenchments, while at the same time guarding against unanticipated shifts in the underlying trend.

If the closing price of the day that sets off the double top or bottom formation substantially overshoots the hypothetical support or resistance level, the potential reward on the trade might barely exceed the estimated risk. In such a situation, a trader might want to wait for a pullback before initiating the trade, in order to attain a better reward/risk ratio.

Forex Minimum Measuring Objective

If the third rally fizzles out before reaching the head, and if prices on the third pullback close below an imaginary line connecting points

Estimated Risk

The trend line connecting the head and the right shoulder is called a “fail-safe line.” Depending on the shape of the formation, either the neckline or the fail-safe line could be farther from the entry point. A protective stop-loss order should be placed just beyond the farther of the two trendlines, allowing for a minor retracement of prices without getting needlessly stopped out.






With a possible left shoulder formed at 387.75 on April 4 and the right shoulder formed on May 9 at 387.80. The head-and-shoulders top was set off on May 14 on a close below the neckline. However, prices broke through the fail-safe line connecting the head and the right shoulder on May 28, stopping out the short trade and negating the hypothesis of a
head-and-shoulders top.

DOUBLE TOPS AND BOTTOMS

A double top is formed by a pair of peaks at approximately the same price level. Further, prices must close below the low established between the two tops before a double top formation is activated. The retreat from the first peak to the valley is marked by light volume. Volume picks up on the ascent to the second peak but falls short of the volume accompanying the earlier ascent. Finally, we see a pickup in volume as prices decline for a second time. A double bottom is simply a double top turned upside down, with the foregoing rules, appropriately modified, equally applicable.

As a rule, a double top formation is an indication of bearishness, especially if the right half of the double top is lower than the left half. Similarly, a double bottom formation is bullish, particularly if the right half of the double bottom is higher than the left half. The market unsuccessfully attempted to test the previous peak (trough), signalling bearishness (bullishness).

Estimating risk and reward on commonly Observed patterns

Mechanical systems are generally trend-following in nature, reacting to shifts in the underlying trend instead of trying to predict where the market is headed. Therefore, they do not lend themselves easily to reward estimation. Accordingly, in this chapter we shall restrict ourselves to a chart-based approach to risk and reward estimation. The patterns outlined by Edwards and Magee’ form the basis for our discussion.



The measuring objectives and risk estimates for each pattern are based on the authors’ premise that the market “goes right on repeating the same old movements in much the same old routine. While the measuring objectives are good guides and have solid historical foundations to back them, they are by no means infallible. The actual reward may under- or overshoot the expected target.

With this qualifier, we begin an analysis of the most commonly observed reversal and continuation (or consolidation) patterns, illustrating how risk and reward can be estimated in each case. First, we will cover four major reversal patterns:

1. Head-and-shoulders formation

2. Double or triple tops and bottoms

3. Saucers or rounded tops and bottoms

4. V-formations, spikes, and island tops and bottoms

Next, we will focus on the three most commonly observed continuation or consolidation patterns:

1. Symmetrical and right-angle triangles

2. Wedges

3. Flags

HEAD-AND-SHOULDERS FORMATION

Perhaps the most reliable of all reversal patterns, this formation can occur either as a head-and-shoulders top, signifying a market top, or as an inverted head-and-shoulders, signifying a market bottom. We shall concentrate on a head-and-shoulders top formation, with the understanding that the principles regarding risk and reward estimation are equally applicable to a head-and-shoulders bottom. A theoretical head-and-shoulders top formation is described in details.

This rally fails to reach the height of the head before yet another pullback occurs, setting off a right shoulder formation. If the third rally takes prices above the head at 3, we have what is known as a broadening top formation rather than a head-and-shoulders reversal. Therefore, a chartist ought not to assume that a head-and-shoulders formation is in place simply because he observes what appears to be a left shoulder and a head. This is particularly important, since broadening top formations do not typically obey the same measuring objectives as do head-and-shoulders reversals.

The Importance of Defining Risk

Regardless of the technique adopted, the practice of predefining the maximum permissible risk on a trade is important, since it helps the trader think through a series of important related questions:

1.How significant is the risk in relation to available capital?

2. Does the potential reward justify the risk?

In the context of questions 1 and 2 and of other trading opportunities available concurrently, what proportion of capital, if any, should be risked to the commodity in question?


Ruin is defined as the inability to trade as a result of losses wiping out available capital. One obvious determinant of the risk of ruin is the probability of trading success: the higher the probability of success, the lower the risk of ruin. Similarly, the higher the ratio of the average dollar win to the average dollar loss-known as the payoff ratio- the lower
the risk of ruin. Both these factors are trading system-dependent.

Yet another crucial component influencing the risk of ruin is the proportion of capital risked to trading. This is a money management consideration. If a trader risks everything he or she has to a single trade, and the trade does not materialize as expected, there is a high probability of being ruined. Alternatively, if the amount risked on a bad trade represents only a small proportion of a trader’s capital, the risk of ruin is mitigated. All three factors interact to determine the risk of ruin.

It gives the risk of ruin for a given probability of success, payoff ratio, and exposure fraction. Assume that the trader is aware of the probability of trading success and the payoff ratio for the trades he has effected. If the trader wishes to fix the risk of ruin at a certain level, he or she can estimate the proportion of capital to be risked to trading at any given time. This procedure allows the trader to control his or her risk of ruin.

Reward estimates are particularly useful in capital allocation decisions, when they are synthesized with margin requirements and permissible risk to determine the overall desirability of a trade. The higher the estimated reward for a given margin investment, the higher the potential return on investment. Similarly, the higher the estimated reward for a permissible dollar risk, the higher the reward/risk ratio.

Forex Trading Futures

Let's say that someone is trading S&P futures and using very tight stops. In all likelihood, they'll get stopped out hundreds of times in one year. I'd bet in many cases, at the end of the year, when you add up all those hundreds of small losses from tight stops, it comes to much more than a few large losses through somewhat looser stops.

Now, this is not to say that you should take excessive risk. You should have your stop far enough away that random noise won't take you out. Suppose someone decides to dump a position or a sell program kicks off, this has absolutely nothing to do with the overall market or the reason you are in the trade in the first place.

People try to trade a high-flying stock like eBay with a $2 price stop. The stock trades in a range of over $30 in one day alone. People are kidding themselves if they think they can trade a stock like this with such a tight stop. In a case like this they will almost always be guaranteed a loss. The same applies to other markets.

Forex Investment

When active investors get more investment cash, they plow it into their mutual funds or buy individual stocks. The investor’s game seems to consist of selective hitchhiking on a freeway that is only going in one direction with the object of getting a ride from the Mercedes driving in the fast lane. They don’t know how far the car is going to go and they don’t really know when to bail out when the car starts driving in reverse. They are slow to switch cars when one hits the breaks, runs out of gas or blows a head gasket.

There is a great amount of hope and faith involved. Many of these active investors don’t pay attention because they operate under the assumption, reinforced by a 20-year old bull, that the market eventually will go up again and the safe thing to do is hold on or, smarter yet, buy more to lower the cost basis on the position. In this game it doesn’t matter very much whether the car has good brakes or seatbelts the gas pedal and cruise control are all that matter. This sort of trading can work in good times, but when the bull turns into a bear, there is going to be a big pileup of fancy cars on the freeway full of drivers who don’t know how to deal with the reality of investing risk.

No professional money manager that I know risks more than 5% per trade; most keep it much lower that that. I think more important than how much you risk is how much you can lose above and beyond that risk. At least once a year, some extraordinary event will create a price shock and you'll lose at least twice what you thought your max loss per trade was. Therefore, I never risk more than 2.5% on any given trade. That way, the worst that can happen to me on anyone trade is probably twice that amount (a 5% loss).

Every decade and often much less, something really "bad" will occur: someone will get assassinated, a war will break out, or some sort of financial meltdown will take place. The system can never adjust for this. These things do and will happen. For instance, the crash in 1987 took out many professional option sellers in just one day.
The bottom line is that everyone is searching for a method or system that will generate enormous profits. What they fail to realize is that controlling risk is much more important than the system itself. No matter how good the system, without risk control it will surely blow up.

Why it's so important to keep it within reason. We showed that the percentage to recover from a drawdown increased at a geometric rate as the drawdown increases. For instance, a 60% loss of capital requires a 150% return on the remaining capital just to get back to breakeven; a 70% loss requires a return of 233%, and so forth.

In the second part of the series we looked at 17 general guidelines that should help to protect capital and ensure profits as a trader. These included risk control techniques such as use of stops, keeping drawdowns within reason, portfolio correlation, judging risk-to-reward, volatility of markets, understanding the instrument being traded (i.e., derivatives), percent per trade risk and overall portfolio risk.

Forex My Views

We looked at techniques to help ensure long-term survival and capturing profits such as being adequately capitalized 2-for-1 money management and taking windfall profits. And finally, we touched upon the psychological impact of losses.

It’s surprising that even many active traders and investors have no idea what money management is about. They generally entertain a fuzzy notion that it has to do with setting stops, and that discipline is involved to make sure you execute the stops when they are hit, but their understanding doesn’t go much further. Most people seem content to let their brokers track their trades for them, and the tools provided by the brokerage sites are adequate to the task.

But none of the online broker rating services tell you about brokers who provide the tools to help you manage these risks, and none of the traditional online or even most hyperactive day trading b brokerage firms seem to cover this important contributor to trading success. Why is this? Perhaps it can be explained by the extended bull run this market has enjoyed since 1982, and the speculative, maniacal extended leg of the bull market fueled by the dot.com land rush since 1997.

This type of market — where making money consists of taking a ride on the back of the bull trend and buying the dips — tends to turn the merely bold (and possibly reckless) into market geniuses. The perceived risk in stock market investing has been very low, so the need to manage that risk has not been a pressing concern. Why worry when it will always come back and you can make a killing if you buy more? More important to success than managing risk was the ability to charm your broker into getting you into the latest IPO allocation.

There are really two types of people operating in the financial markets: traders and investors. It is useful to understand the difference between the two — it may explain, in part, why so many people ignore risk management. Many people who call themselves traders are, in reality, active investors. The typical investor only purchases stocks and buys as many as possible with all the available cash in his or her account. The risk-free position, for the typical investor, is to be fully invested in stocks for the long term, because, as we all know, stocks always go up.