Ever notice that. That there sometimes seems to be a tension that builds in a room. And then… all hell breaks loose. This is the feeling I’m getting right now about the FX Market. Do you fell this as well?

The USD has been strengthening for weeks and sooner or latter traders are going to align there overall sentiment and emotions and send the markets the other way.

sometimes when this happens a pattern know as an ending diagonal develops (Elliott Wave). This usually signals a strong reversal if indeed the pattern is correctly identified. I say this because there is always the chance of a miss-read.

What I watching right now is the possibility of an ending diagonal on the GBPUSD. The pattern shows up because there is a fight going on between the Bulls and Bears. So a relatively consistent pattern shows up at the end of long market move that once complete gives way to a sudden correction.

Here’s a snapshot of what I’m watching. I will wait for the pattern to show sings of completion and when I see an engulfing candle in the opposite direction I will become a buyer.

Cheers and good trading.

I’m currently reading (re-reading) the Way of The Turtle. It’s written by one of the original group that was mentored by some of the worlds most successful traders. I highly recommend this book.

I keep finding great little gems of wisdom that all add up to a great way of approaching trading. Here’s the piece I want to share today.

Don’t Throw Good Money After Bad: I remember my mother saying this. And the older I get the smarter she has become. In the book this is referred to as "Sunk Cost effect". In business "Sunk costs" have been spent and cannot be recovered. Have you ever worked for a firm where there was an almost foolish tendency to stay with an old system and try to keep repairing it even when it was so inefficient because there had been a recent investment in the system or process?

How about that old car. When someone spends thousands on the transmission only to have the motor blow up, that it will now cost several more thousands to replace or repair. When does it stop? where to you get out?

The same goes for trading. So to be a good trader, one needs to not view a draw-down as a real value. It just simply isn’t. Even if the market turns in your favour, you still have to make up the total loss before you start making profit.

So learn to set firm stop losses and get out where you know you should the first time. Don’t throw good money after bad.

I’ve written about this in the past and will continue to write about it in the future as I believe it is the most important piece for most traders to understand.

First of all; here a few questions to ask yourself.

    * How much money do you expect to make from trading? $1,000/month, $10,000/month, $1,000,000?
    * Do you have a plan on how you will get there? How much you should increase every month towards your goal?
    * Do you have a specific system that is written down? It should be in a form where you could give it to another trader and they would understand it. And even if you trade on fundamentals you MUST have a technical trading plan to go with it.
    * Have you tested it over a period of time? How many paper trades have you done for your system? More than 100?
    * Do you understand how to use a Stop-Loss to keep your risk at less than 5% of your account value?

I have been in business all my life. Worked for many organizations and have personally owned my own businesses. The only ones I have ever seen succeed over the long-term are the ones where planning and risk management where always in focus. So now ask yourself how does a successful business run?

    * Is there planning for revenue and expenses and risk?
      Does a successful business launch into something without testing and risk assessment?
      Does a successful business now when to cut losses?
      Does a successful business have rules and guidelines and policies to follow?

Do you see what I’m getting at? You must measure and have a benchmark to measure against. If you don’t know what you are aiming at you will have no focus and no real way of knowing you are moving forward.

I’ve heard some other teachers and mentors say that the real test is in a live account because this changes the dynamic and real anxiety comes into play. I agree with them BUT I do not believe you simply jump into a live account without a road-map on what you plan to do. If you don’t know where you’re going… any road will do.

I’ve also just posted a new technical report: http://www.fxstreet.com/technical/analysis-reports/fx-weekly-report/2008-08-19.html

I thought it timely to post this as I have received a few comments lately asking for specific prediction on the EUR/USD.

For those of you who are new to trading please learn this one rule right away and never forget it. No one can predict any specific market. Certainly some annalists can come close or be right some of the time but this is quite rare.

The way I trade and what I always recommend to all traders is to never risk more that 5% of your account on any trade by way of the use of a stop loss. NEVER GO OVER THIS! And in fact 2% should be your limit.

You should never enter a trade unless you have written the following down.

• Where is my entry price point and why?
• What is my stop-loss that I will NOT go over?
• Where is my profit point exit.

If you can not answer these questions on every trade you make then until you can, trade only in a demo account until you do this every time and you are profitable.

Treat trading like a business. You would never spend money in a business unless you know the exact amount. Do the same with your trading.

If you are trying to find the bottom on the EUR/USD this is like trying to catch a falling knife. For goodness sake… Let the knife hit the ground first.

I will write more about "Trading as a Business" in the next blog.

Cheers

I would not yet be certain a bottom has formed on the EUR/USD but we certainly moved closer to it today. I had mentioned in my previous post to expect a sudden move down and behold, we saw this happen during the previous session.

I would use caution until we have a clear rejection of the low before becoming an aggressive buyer, as there may still be one final swing lower.

What I would watch for here is a final capitulation of the low in an aggressive and powerful move upward to be the signal that the temporary bottom may be in place.

Cheers

How can we go form such a dramatic move, almost historic in fact to now just moving in a narrow range, trading only a fraction of the amount of just a few days ago.

In Elliott Wave terms (and I love the way Elliott theory helps identify trader sentiment) this is a characteristic of a wave 4 which is where we appear to be in the current pattern. You see traders are now cautious and are taking some profits. Wave 4’s don’t usually move a lot and seem to be purposed mostly for burning time. In fact this is the most common place to see a ‘Triangle’ form. As the ‘Triangle’ develops the anxiety finally builds and pushed the price out the end usually in what is known as a terminal thrust Wave 5.

Note that wave 5 is often known as the fools wave as those who are trading it as a continuation are jumping on a bandwagon that has gone far enough and is usually about to change direction with a blow-off top/bottom.

So be patient and wait for a sign that a least a temporary bottom is place before making any new trading decisions
.

Looking at some of the charts these last few days I hear a voice in my head saying: That can’t keep going deeper? This move has to be over now… For sure this will start correcting next session! Sound familiar? Have you been looking at some charts and doing the same?

We are seeing an almost unprecedented move in favour of the USD over the last few weeks. Trader sentiment has definitely changed towards the Dollar and we are now in a correction of years of overselling.

What happens to our minds in cases like this is as the move goes deeper and deeper we go into a state of disbelief almost, about how far the moves are going. So we want to benefit from the move but part of our minds won’t allow us to jump into a trade in the current direction because it’s akin to jumping onto a moving train. So we watch, thinking that the move will be over soon and that we can catch the counter trend rally. What usually happens here is we do this far too soon and we are stopped out or go negative on our trades at which point we start adding to average down and find ourselves fighting a tide that turns into a tidal wave.

So how do we counter our bad programming?
On your trade plan/rules sheet write down at the very top the most important question to answer before making any trading decision. Are we in a “Trending Market”? or a “Correcting Market”? This is known in Elliott Wave Terms as “Motive Impulsive” “or “Corrective”. What this should do for you is identify what trading type to employ. In a Trending Market you should be trading CONTINUATION trades and in a Correcting Market you should be trading REVERSALS. If you learn to train your mind to key in on this first then when you look to trade, you thoughts should be focused on what is the next best trade rather than on the disbelief of how far the move is going.

Having said that; counter trends will come along in the next few days. Don’t try to guess when… Wait for a clear signal before any new trades. If you miss the counter trend, don’t worry, these moves are just the beginning of more to come over the next few months.

We have uncharacteristically seen a tremendous amount of movement going into the FOMC rate and policy release today. What appears to be driving the market is speculation that the US policy makers are changing their tone on planed rate increases and that a series of upward changes is coming.

We see once again that emotions move the market, not the event itself. This suggests that the very thing to look for once the minutes are released is if the news now disappoints. We are going into the news release highly overbought on the USD. So if traders don’t get the news they expected they may very quickly turn the other way. If they get the news that has been rumored then further continuation is the likely result. The question in that case however is how far can you stretch an overstretched elastic?

So… expect more volatility and be prepared to change your direction bias if the news disappoints. Remember the news may still be that rate increases are coming, but if the language is weak about it, this too may cause a reversal.

Here’s a great example on the CHF/JPY for fractal observation.

It is possible that this pattern is creating a pattern at the end of a similar pattern of one larger degree. In the drawing you can see similarities in the last part of the pattern compared to the larger overall shape.

It is still difficult to tell on this pair if the final pattern is complete. When it is, we will see evidence in this in an overall sentiment change by the traders. You see it’s the emotions of the traders that create these patterns making them ever so smaller (or sometimes larger) in appearance as the emotions oscillate back and forth in what they are believing and feeling as they trade.

In this case as the patterns becomes smaller, they are changing their minds with increasing frequency withing the greater overall bullish sentiment. What will eventually happen is a final very small pattern looking just like the largest one will form at the end of the channel (This may or may not have happened as it is hard to read the last smallest pattern). When this occurs, then the overall greater sentiment will take place with a longer term direction change and a new pattern will emerge.

This will provide great trading opportunities knowing the general direction of the pair going forward for some time to come. In fact this reversal will likely foretell a multi-year top.

This theory is also somewhat evident in Sunil Mangwani’s blog of http://forexology.fxstreet.com/2008/07/harmonics-withi.html