Part 2: A Simple But Powerful Strategy for Newbies

In part one of our article, we discussed pattern recognition on forex charts, using the Gbp/jpy as our example. Let’s take a look at the 4 hour chart.

I have drawn red horizontal lines at swing lows and swing highs. Why? These are areas of rejection where the market price changed directions. In this 4 hour chart, we can see that Geppy is in a serious downtrend after being rejected around the 214 price. At the top of the chart you can see Geppy got sold hard at 213.90 and then again at 213.47. It made a lower high. This is bearish. We look for lower highs and lower lows to be formed by candle closes in a downtrend. Opposite for an uptrend. Look at the cluster of sma’s at the 210/211 area. This area is called cluster resistance and will take a strong push to break it. We can be confident that if the downtrend is still in force, we will get a rejection from this area on the next trading day if we get a retrace upwards. At some point the downtrend will run out of steam, retrace, and reload for another push down. The monthly Geppy chart is telling us that. Looking at the monthly we can see that the price made it down to 206.22 and closed the candle below the 5 sma low. This is bearish. A retrace up will target the 5 sma high at the 207.50 area, and if that breaks, then the retrace target is a previous swing low at 208.74. A small long position will collect daily interest until that retrace area is hit. The position is contra-trend and risky, so you set your stop loss below the previous swing low at 204.59 area. Upside target will be as high as 209 or 210 possibly, depending on market sentiment. Since this position is contra-trend, the lot size should be very small so that a drawdown wont kill your balance. Once the retrace is confirmed, by price action in relation to the 5 sma channel, you can enter the trade with less risk. Confirmation would be an hourly candle close above the 5 sma high, and a 4 hour candle close above the 5 sma high. Where the candles close is crucial to know the trend direction. As long as the candles close above the hourly and 4 hour 5 sma channel Geppy will retrace up to our targets. The stop loss is then moved up to the 5 sma low area, then to break even if the retrace is significant. Once the stop loss is at break even or +1, then you have a no risk trade, collecting daily interest. If the retrace gets rejected, your trade is stopped out at no loss. If the retrace continues to our targets, then we book a gain of 100/200 pips, plus interest.

Again, the lot size size must be the smallest possible for this contra-trend position. In a major downtrend like the Geppy is in at the moment, we are looking to sell into any rallies for our trades, with occasional scalps on the retrace. If you are risk averse dont try to scalp against a trend. Be patient and wait for the retrace to hit our targets to the upside, and sell the rejection of them for a continuation of the downmove to the 200 area. A retrace to 209/210 area would be worth +900/1,000 pips if Geppy retraces there and the resumes downward to 200, as the monthly is telling us it will do that.

The simple strategy is this: Look for areas of previous rejection on higher times frames, and target them as entries for resumption of trend, or as scalping targets contra-trend, depending on your risk tolerance. Use tiny lot sizes that can withstand drawdowns, and be patient. Use the Zigzag indicator to count the number of waves, and to draw trendlines for support/resistance. Draw horizontal lines at the tops and bottoms of the zigzag indicator. Watch how the price action respects them. When we see a breakout of these fibs, sma’s, and trendlines, we know that a retrace will occur. Almost all breakouts retrace first before resuming. Wait for the retrace if you missed the breakout. Do not chase the market. Wait for the market to come to your targets. The big players know exactly where most newbies place their stops losses. A tight stop will be hit.