After more than 2 decades of trading forex and training students around the world, it still amazes me when I see some trading tactics. Trading forex involves some skills in fundamental thinking, technical analysis, but most importantly -common sense. The latter is the most difficult. Let me cite an example that happens a great deal in many currency pairs. The currency pair rises and breaks a side ways channel. The trader perceives this as being “oversold” and sells the pair while it is rising. Yet it keeps going higher. The trader, instead of getting out of the way, until the patterns become more predictable, instead, sells again, determined to “beat” the pattern and see it reverse. It rises again instead. The result is that the trader has loading his position in the wrong direction and is now 100 pips or more down. That could be devastating.
This is exactly what happened in the EURUSD on July 15th. It kept going up and up. It looked oversold, but that did not matter. The sentiment for a stronger EURUSD was trumping normal tendencies to revert to the mean. Just look at the EURUSD 30 Minute Chart of July 15th. The EURUSD went from 127.17 to 1.2988 without much resistance.
(click to view)
The question becomes just how could a trader avoid being mislead by thinking the currency pair was about to reverse? First, some key advice: Don’t anticipate a reversal- confirm it. Its far better to actually join the action going down than to put on a trade while it is actually increasing assuming it will reverse. Having said that, a useful tactic is to: 1) Put on a Fib line from the most recent low to the most recent high. 2) Once the fib line is drawn- locate the 38.2% line; 3) Don’t enter the reversal trade unless it closes below the 38.2% line.
If this rule would have been used, the trader would have seen NO confirmation of a reversal. In fact, not once did it reverse down 38.2% from off any high. It did retrace 23.6% and then bounced back.
The rule of waiting for the price to retrace and close below the 38.2 % keeps one out of harms way. Many ask the question of why do fibs seem to work. We don’t really know the answer. We do know that price action often follows fib based ratios and that should be enough. The failure to retrace at least below the 38.2% level confirmed that the bullish sentiment for the EURUSD was still very strong.
There is time to be right in forex by confirming reversals and not anticipating them. (click to view)
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