EUR/USD Candlesticks and Ichimoku Weekly Analysis

EUR/USD Candlesticks and Ichimoku Analysis Last Candlesticks pattern / Time of formation / Trend bias Weekly             Morning star         /   01 Mar 2009     /  Sideways Daily                      Doji                 /   02 Mar 2010     /  Sideways Although the single currency fell again last week to a low of 1.3114 (almost reached our indicated downside target at 1.3110 - 61.8% projection of 1.4580 to 1.3433 measuring from 1.3819) last week, lack of follow through selling suggests minor consolidation would take place this week ahead of the release of key U.S. data and expect recovery to be limited to the Tenkan-Sen (now at 1.3467) and bring retest of said support. Break there would extend the decline from 2009 high of 1.5145 to resumed recent decline from 1.5145 (2009 high) to 1.3080 (1.618 times projection of 1.5145-1.4218 measuring from 1.4580) and possibly the psychological support at 1.3000 but reckon chart support at 1.2885 would hold from here. On the upside, a weekly close above 1.3520/30 would suggest a temporary low has possibly been formed and risk stronger rebound towards resistance at 1.3692 but a weekly close above the Ichimoku cloud bottom (now at 1.3726) is needed to confirm and bring correction to next chart point at 1.3819 and then 1.3890 (38.2% Fibonacci retracement of 1.5145-1.3114) which is likely to hold from here. On the daily chart, despite last week’s resumption of downtrend to another low of 1.3114, as euro has recovered from there partly due to profit-taking and short-covering ahead of U.S. data should bring minor correction towards the Kijun-Sen (now at 1.3403), however, the Ichimoku cloud bottom (now at 1.3542) should hold and bring another decline later. Break of said support would extend downtrend to 1.3080 (1.618 times projection of 1.5145 to 1.4218 measuring from 1.4580) and then test of psychological support at 1.3000. On the upside, only a daily close above the Ichimoku cloud bottom would be the first sign that a temporary low has been formed and bring test of resistance at 1.3692 and once this level is penetrated, this would confirm and then retracement towards next resistance at 1.3819 would follow.

Fibonacci Retracement Description ..

Fibonacci Who?

We will be using Fibonacci ratios a lot in our trading so you better learn it and love it like your mother. Fibonacci is a huge subject and there are many different studies of Fibonacci with weird names but we’re going to stick to two:retracement and extension.

Let me first start by introducing you to the Fib man himself…Leonard Fibonacci.

Leonard Fibonacci was a famous Italian mathematician, also called a super duper uber geek, who had an “aha!” moment and discovered a simple series of numbers that created ratios describing the natural proportions of things in the universe

The ratios arise from the following number series: 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144 ……

This series of numbers is derived by starting with 1 followed by 2 and then adding 1 + 2 to get 3, the third number. Then, adding 2 + 3 to get 5, the fourth number, and so on.

After the first few numbers in the sequence, if you measure the ratio of any number to that of the next higher number you get .618. For example, 34 divided by 55 equals 0.618.

If you measure the ratio between alternate numbers you get .382. For example, 34 divided by 89 = 0.382 and that’s as far as into the explanation as we’ll go.

These ratios are called the “golden mean.” Okay that’s enough mumbo jumbo. Even I’m about to fall asleep with all these numbers. I'll just cut to the chase; these are the ratios you have to know:

Fibonacci Retracement Levels
0.236, 0.382, 0.500, 0.618, 0.764

Fibonacci Extension Levels
0, 0.382, 0.618, 1.000, 1.382, 1.618

You won’t really need to know how to calculate all of this. Your charting software will do all the work for you. But it’s always good to be familiar with the basic theory behind the indicator so you’ll have knowledge to impress your date.

Traders use the Fibonacci retracement levels as support and resistance levels. Since so many traders watch these same levels and place buy and sell orders on them to enter trades or place stops, the support and resistance levels become a self-fulfilling expectation.

Traders use the Fibonacci extension levels as profit taking levels. Again, since so many traders are watching these levels and placing buy and sell orders to take profits, this tool usually works due self-fulfilling expectations.

Most charting software includes both Fibonacci retracement levels and extension level tools. In order to apply Fibonacci levels to your charts, you’ll need to identify Swing High and Swing Low points.

A Swing High is a candlestick with at least two lower highs on both the left and right of itself.

A Swing Low is a candlestick with at least two higher lows on both the left and right of itself.

Let's take a closer look at Fibonacci retracement levels...

Fibonacci Retracement

In an uptrend, the general idea is to go long the market on a retracement to a Fibonacci support level. In order to find the retracement levels, you would click on a significant Swing Low and drag the cursor to the most recent Swing High. This will display each of the Retracement Levels showing both the ratio and corresponding price level. Let’s take a look at some examples of markets in an uptrend.

This is an hourly chart of USD/JPY. Here we plotted the Fibonacci Retracement Levels by clicking on the Swing Low at 110.78 on 07/12/05 and dragging the cursor to the Swing High at 112.27 on 07/13/05. You can see the levels plotted by the software. The Retracement Levels were 111.92 (0.236), 111.70 (0.382), 111.52 (0.500), and 111.35 (0.618). Now the expectation is that if USD/JPY retraces from this high, it will find support at one of the Fibonacci Levels because traders will be placing buy orders at these levels as the market pulls back.



Now let’s look at what actually happened after the Swing High occurred. The market pulled back right through the 0.236 level and continued the next day piercing the 0.382 level but never actually closing below it.  Later on that day, the market resumed its upward move. Clearly buying at the 0.382 level would have been a good short term trade.



Now let’s see how we would use Fibonacci Retracement Levels during a downtrend. This is an hourly chart for EUR/USD. As you can see, we found our Swing High at 1.3278 on 02/28/05 and our Swing Low at 1.3169 a couple hours later. The Retracement Levels were 1.3236 (0.618), 1.3224 (0.500), 1.3211 (0.382), and 1.3195 (.236). The expectation for a downtrend is if it retraces from this low, it will encounter resistance at one of the Fibonacci Levels because traders will be placing sell orders at these levels as the market attempts to rally.



Let’s check out what happened next. Now isn’t that a thing of beauty! The market did try to rally but it barely past the 0.500 level spiking to a high 1.3227 and it actually closed below it. After that bar, you can see that the rally reversed and the downward move continued. You would have made some nice dough selling at the 0.382 level.



Here’s another example. This is an hourly chart for GBP/USD. We had a Swing High of 1.7438 on 07/26/05 and a Swing Low of 1.7336 the next day. So our Retracement Levels are: 1.7399 (0.618), 1.7387 (0.500), 1.7375 (0.382), and 1.7360 (0.236). Looking at the chart, the market looks like it tried to break the 0.500 level on several occasions, but try as it may, it failed. So would putting a sell order at the 0.500 level be a good trade?



If you did, you would have lost some serious cheddar! Take a look at what happened. The Swing Low looked to be the bottom for this downtrend as the market rallied above the Swing High point.



You can see from these examples the market usually finds at least temporary support (during an uptrend) or resistance (during a downtrend) at the Fibonacci Retracements Levels. It’s apparent that there a few problems to deal with here. There’s no way of knowing which level will provide support. The 0.236 seems to provide the weakest support/resistance, while the other levels provide support/resistance at about the same frequency. Even though the charts above show the market usually only retracing to the 0.382 level, it doesn’t mean the price will hit that level every time and reverse. Sometimes it’ll hit the 0.500 and reverse, other times it’ll hit the 0.618 and reverse, and other times the price will totally ignore Mr. Fibonacci and blow past all the levels like similar to the way Allen Iverson blows past his defenders with his nasty first step. Remember, the market will not always resume its uptrend after finding temporary support, but instead continue to decline below the last Swing Low. Same thing for a downtrend. The market may instead decide to continue above the last Swing High.

The placement of stops is a challenge. It’s probably best to place stops below the last Swing Low (on an uptrend) or above the Swing High (on a downtrend), but this requires taking a high level of risk in proportion to the likely profit potential in the trade. This is called reward-to-risk ratio. In a later lesson, you will learn more money management and risk control and how you would only take trades with certain reward-to-risk ratios.

Another problem is determining which Swing Low and Swing High points to start from to create the Fibonacci Retracement Levels. People look at chartsdifferently and so will have their own version of where the Swing High and Swing Low points should be. The point is, there is no one right way to do it, but the bad thing is sometimes it becomes a guessing game.

De Mark Trend Lines.

When searching for Forex information on the internet you are likely to find articles relating to trendlines and trendline analysis.

Tom DeMark is a specialist in the field of technical market analysis and his best-selling book "The New Science of Technical Analysis" released in 1994 spells out some innovative techniques when it comes to the use of trendlines.

Much Forex information on the internet is of a general nature, and many articles are written about Forex by individuals who are not traders themselves. Tom DeMark on the other hand has had a long career with institutions trading stocks, futures, currencies and options.

His guidelines on the use of trendlines are very specific and they can be helpful to the newer trader who is searching for reliable Forex information on how to use standard indicators.

Here is a brief step-by-step description of how to draw DeMark trendlines:

Note: The term swing high and swing low (also called cycle high and cycle low) refers to the following:

In An Uptrend: A swing high is the wick of a candle that is higher than the wick of the candle to the left and right.

In A Downtrend: A swing low is the wick of a candle that is lower than the wick of the candle to the left and right.

Obviously the more candles to the left and right that are higher in a swing low or lower in a swing high makes the swing or cycle more significant.

An uptrend is where price is making higher highs and higher lows. A downtrend is where price is making lower highs and lower lows.

Drawing DeMark Trendlines

Drawing Trendlines In An Uptrend

1. Examine the bottoms of the candles on your chart and identify the most recent candle wick that is lower than the candle wicks to the immediate right and left of it.


2. Look left on the chart, and identify the previous low candle that has candle wicks higher to the immediate right and left of it which is lower than the current low candle.


3. Now draw a line from the current lowest candle to the previous lowest candle (drawing from right to left).


4. Now take the end of the newly drawn line which stops at the current low candle and extend it forward some distance (drawing from the present position to the right).

Drawing Trendlines In A Downtrend

1. Examine the tops of the candles on your chart and identify the most recent candle wick that is higher than the candle wicks to the immediate right and left of it.


2. Look left on the chart, and identify the previous high candle that has candle wicks lower to the immediate right and left of it which is higher than the current high candle.


3. Now draw a line from the current highest candle to the previous highest candle (drawing from right to left).


4. Now take the end of the newly drawn line which stops at the current high candle and extend it forward some distance (drawing from the present position to the right).

You have now drawn a Tom DeMark trendline.

This can now be a reference point for future price action. It will often be observed that price will come and check this level. If it breaks through, it can mean a change in direction, the significance of which will depend on the time frame being used.

Trendlines drawn on 5 minute or 15 minute charts have much lesser significance than trendlines drawn on higher time frames such as the 1 hour, 4 hour, or daily.

Caution Required

Much Forex information extols the virtues of trendlines as an indicator of possible future price action.

Mr. DeMark certainly has made this a science and his detailed approach to drawing trendlines is certainly more accurate than just drawing general trendlines along the bottoms and tops of trends according to the way the eye sees.

However, trendlines in themselves do not indicate where high probability trades can be taken.

It is important to use a variety of indicators before pulling the trigger. Examining previous levels of support and resistance is probably far more significant in determining where price is likely to hesitate that watching trendlines.

However, they can be useful. If you find a key support or resistance level also coincides with a Fibonacci retracement or extension level which is also at an intersection with a trendline, then you have built a reasonably solid case for a trade.


Using Trendline Analysis As Part Of Your Forex Strategy

Often, not always, price will break a trendline and move away 10 or 20 pips. Then, it comes back to test the backside of that trendline. That’s where you enter the trade.

If the trendline break coincides with your other favorite indicators such as:

• Pivot Points


• Fibonacci Calculations


• Previous Support Or Resistance

then set an entry order for price to take you in when it comes back to test that level.

That way you enter the trade at an optimum level and squeeze even more pips out of the move.

Note the examples below:







USD/CHF
1 Hour Chart

See how price broke the trendline, then came back to test the backside.

If you look carefully at the chart and run your eyes left, you will see that the trendline bounce also coincides with a previous support/resistance level.

If you did some Fibonacci calculations you would also find that same point matches with 50 and 62% retracement levels.

With that convergence of factors, the trendline backside test makes a good entry point!

Importance of Support and Resistance..

In almost every issue of the RightLine Report we refer to support and resistance levels. Indeed, many of our stock entry points are based on potential price reactions to these important junctions. So just what are support and resistance levels, and why are they so important?

In the book "Trading For A Living," Dr. Alex Elder gives a simple, but effective image of support and resistance - "A ball hits the floor and bounces. It drops after it hits the ceiling. Support and resistance is like a floor and a ceiling, with prices sandwiched between them." When a stock's price has fallen to a level where demand at that price increases and buyers begin to buy, this creates a "floor" or support level. When a stock's price rises to a level where demand decreases and owners begin to sell to lock in their profits, this creates the "ceiling" or resistance level.

Why? Because investors and traders are people and they have memories! Those that follow a particular stock just "know" that it "never (or rarely) falls below xx" and it "never rises above yy". The "floor" and the "ceiling" are not fixed barriers you can touch; rather they are psychological barriers. These psychological barriers are built when traders who bought the stock at the "ceiling" are grateful to be able to get out of their positions and just break even. They were beating themselves over the head from the day they bought it, swearing they will never be so "stupid" again, and praying that they can just get out without losing their shirts.

How To Recognize Support and Resistance

You can identify support and resistance levels by studying a chart. Look for a series of low points where a stock falls to this level, but then falls no further. This is a support level. When you find that a stock rises to a certain high, but no higher, you have found a resistance level. If you find yourself struggling to find the support or resistance levels, then those levels may be not be very strong.



Strength of Support or Resistance

The more times that a stock bounces off support and falls back from resistance, the stronger these support and resistance levels become. It creates a self-fulfilling prophecy. The more often it happens, the more likely it is to happen again. The more those historical patterns repeat themselves, the more traders "know," and the more confident they become in forecasting the future behavior of the stock. Some stocks become so entrenched in this trading range, that the stock eventually has a hard time breaking through the levels to either the up or downside.

Using Support and Resistance

Long traders will often set a stop slightly below one of the support levels, and short sellers will often set their stops just above resistance. The reason for these stop levels is because investors "know" that historically; these price points are unlikely to be violated. When either of these points is exceeded to the point that stops go into effect, then there is the potential for a powerful price move as automatic buying or selling is set into motion by the stops being triggered.

Trading Ranges

A long-term pattern of a stock's price bouncing between support and resistance levels creates what we call a trading range. Although most charts don't show a predictable pattern, many do. If you find a stock that consistently trades in a range, this may be a good opportunity to benefit from the predictable movement in the stock.

The best way to trade a "rolling stock" or "channeling stock" is to buy just after you start to see the bounce off support and sell just after you start to see it drop back off resistance. Notice that you should wait to see the beginning of the "expected" action before pulling the trigger. Many traders get in the habit of buying or selling before they actually see the stock bounce or fall, hoping to sell at the peak or buy at the low. What these traders risk is that the stock will not do what they expect it to do. By waiting to see the reversal, a trader may give up a small amount of profit, but they will also avoid the risk of selling just before a stock breaks out to the upside or buying just before a stock falls to the downside. There are many range-bound stocks that long-term "buy and hold" investors have sat on for month after month without making any money; on the other hand, the "channel surfer" has made a decent return by buying near the bottom of the pattern and selling near the top. Not all stocks are candidates for this type of trading, but you will see them from time to time.

Breakouts

We've all seen charts of stocks that traded in a range for a time, and then bust through resistance to shoot effortlessly higher. Why does this happen? Recall that the more times a stock hits a support or resistance level, the "stronger" that level apparently becomes. Being astute traders we just "know" that a stock's price is unlikely to exceed a strong resistance level. The more of us that recognize that fact, the more short sellers there are likely to be lining up to short the stock. And the more short sellers there are the more buy stops there will be set at that "unlikely" level.

But, let's say the stock receives a strong recommendation from three analysts who feel the stock is a "strong buy." The result? Demand for the stock goes up, short sellers are "squeezed" out as they are stopped out and are forced to buy the stock to cover their short positions, creating what we affectionately term a "short squeeze." Everyone who thought they knew where the ceiling (resistance) was, no longer holds a position in that stock. What once was the ceiling becomes the new floor, or support level.

Once a stock breaks out above strong resistance, it takes some time to create and recognize the new ceiling. Short sellers become less likely to step in because they can no longer anticipate where the stock is likely to "bounce back down." RightLine readers are familiar with the term "blue-sky territory" or "blue-sky breakout." We use the term blue-sky to indicate when a stock breaks above all previous resistance points.

Fallouts

Just as support can be considered the opposite of resistance, the phenomenon just described as a breakout can also occur to the downside. This is what we refer to as fallout. Traders who own a stock long will often have stops set just below significant support levels. If these support levels are broken, traders will be stopped out if the stock falls below support. The increased selling volume will normally cause a quick and decisive drop in the stock because those buyers who "knew" the floor (support) level, are now are out of the stock, leaving very few buyers until the stock hits the next level of support.

50 DMA Support Level

Before wrapping up this discussion, we want to draw your attention to the fact that many technical analysis packages are programmed with 50 DMA (Daily Moving Average) rebounds in mind. Though the behavior of each stock is unique, you will often see that as a stock falls to near the 50 DMA, buyers come in, reversing the downtrend and causing the stock to "bounce." By reviewing a few dozen stocks, you will notice that some stocks have a very predictable pattern of bouncing off support at the 50 DMA. While you won't find this same pattern among all stocks, when you do find it, it can be quite valuable. Just as in the case when traders "know" the trading range of a stock is stuck between lateral support and resistance levels (trading range or channel), they will also look to the 50 DMA to provide an indication of support. We see this happen especially on strong, trending stocks. Pre-programmed technical analysis packages have the 50 DMA built in, creating an even stronger tendency for a self-fulfilling prophecy. Many of the stocks covered in the Right Line report tend to find support at their 50 or 22 DMAs.

Understanding the concept of support, resistance, trading ranges, breakouts and fallouts can be quite valuable to all traders. Support and resistance is the one of the strongest and most dependable tools available to the trader. Remember that it is best to use any tool along with other indicators when deciding whether and/or when to take or exit a position.

What is Support and Resistance???

Support and Resistance

Support and resistance is one of the most widely used concepts in trading. Strangely enough, everyone seems to have their own idea on how you should measure support and resistance.

Let’s just take a look at the basics first.

Look at the diagram above. As you can see, this zigzag pattern is making its way up (bull market). When the market moves up and then pulls back, the highest point reached before it pulled back is now resistance.

As the market continues up again, the lowest point reached before it started back is now support. In this way resistance and support are continually formed as the market oscillates over time. The reverse of course is true of the downtrend.

Plotting Support and Resistance

One thing to remember is that support and resistance levels are not exact numbers. Often times you will see a support or resistance level that appears broken, but soon after find out that the market was just testing it. With candlestick charts, these "tests" of support and resistance are usually represented by the candlestick shadows.



Notice how the shadows of the candles tested the 2500 resistance level. At those times it seemed like the market was "breaking" resistance. However, in hindsight we can see that the market was merely testing that level.

So how do we truly know if support or resistance is broken?

There is no definite answer to this question. Some argue that a support or resistance level is broken if the market can actually close past that level. However, you will find that this is not always the case. Let's take our same example from above and see what happened when the price actually closed past the 2500 resistance level.



In this case, the price had closed twice above the 2500 resistance level but both times ended up falling back down below it. If you had believed that these were real breakouts and bought this pair, you would've been seriously hurtin! Looking at the chart now, you can visually see and come to the conclusion that the resistance was not actually broken; and that it is still very much in tact and now even stronger.

So to help you filter out these false breakouts, you should think of support and resistance more of as "zones" rather than concrete numbers. One way to help you find these zones is to plot support and resistance on a line chart rather than a candlestick chart. The reason is that line charts only show you the closing price while candlesticks add the extreme highs and lows to the picture. These highs and lows can be misleading because often times they are just the "knee-jerk" reactions of the market. It's like when someone is doing something really strange, but when asked about it, they simply reply, "Sorry, it's just a reflex."

When plotting support and resistance, you don't want the reflexes of the market. You only want to plot its intentional movements.

Looking at the line chart, you want to plot your support and resistance lines around areas where you can see the price forming several peaks or valleys.

Other interesting tidbits about support and resistance:

1. When the market passes through resistance, that resistance now becomes support.


2. The more often price tests a level of resistance or support without breaking it the stronger the area of resistance or support is.