Part one (introduction)
By Michael Storm pro scalper– Follow Michael on Twitter
Every trader has developed strategies over time based on observations. How many times have we longed or shorted a currency pair, only to see it go against us by 10-20 pips and make us nervous, or doubt the validity of our trade? What if you could strike with precision and maximize your entries and exits to a far greater degree? Patterns in technical analysis repeat and repeat often. It doesn’t really matter what time frame you are looking at whether it be a 1 min chart, 5, 15, 1 hour or a daily chart. Each bar or candle on any given chart is made up of trades. It is the collective trades in a never ending war, a battle if you will. A battle between the bears and bulls. after you push the button to buy or sell, the very next few ticks determine who was right, who was wrong. Now, nothing moves in a straight line. So there are “pockets”, moments in time that equal opportunity. The traders job is to recognize these moments and trade them with excellence. Its been said that the charts can only do 3 things: Trend up, Trend down, or move sideways. But in reality there is much more than this. There is support and resistance levels that can be tested time and again. Sometimes these levels are breached temporarily and then whipsaw in the other direction again. There are “head-fakes” and “short squeezes” Channel trades, range breaks and countless “patterns”. What is a trader to do?
I would like you to think for a moment about the market maker. He has a job to do, make the market. To be willing to buy or sell on a moments notice. He must “handle” order flow. He has some advantages. On stocks he has a level 3 screen far beyond the day traders level 2 capabilities. He also sees the order flow. He KNOWS who is buying and selling and how much and he has a time frame to work with for his larger orders. Forex is no different. The “big boys” that trade in amounts that would stagger our minds also have to handle the flow of buys or sells and to do the best that they can to keep it within a certain price range for their clients. Now, the market maker pays no commission, his only objective is to “capture the spread” hundreds and hundreds of times a day. He “collects” inventory when prices are “cheap”. He unloads inventory when prices are advantageous. And when prices are in the “euphoria” mode, he is willing to short an awful large amount of size. Waiting for the price to come back down to earth, as it surely will.
As a professional, high speed scalper, who is an active market participant at just about every given moment of the day, I seek to gain somewhere between 3 to 7 and maybe even as high as 10 pips every single minute or so. I also like to build a position by selling into strength or buying into weakness when prices get extreme. I do this anywhere from several dozen to hundreds of times a day. This is not for everyone, obviously. It takes an awful lot of concentration. But I am sure, if you will take the time to read this and go through it to the end, you will gain an insight into some very different and new thoughts, that you might have never thought of and will hopefully help you to hone your trading and gain MORE pips, which is what we all want. It is my position that the Forex market is absolutely perfect for scalping. And I sure love to scalp it all day long.
In a trend ( I am going to use an uptrend as the example) there are pullbacks (which are mild) which do not last long and offer an excellent opportunity to get long. There are “shakeouts” which are more severe and usually attack a prior low or pivot and are necessary to shakeout the weak longs so that price can rise further. Then there are crashes. That just blow through a certain level as if it wasn’t even there and with power, I mean almost unstoppable momentum, crash HARD. Even in these crashes there are moments to trade long, when a correction is surely do. Price cannot move to far to fast without stretching severely like a rubber band. It has to “snap back” a certain amount. just like a fib level (they usually don’t go beyond a third). Take a look at this chart of the GBP/JPY This is a 5 min chart around 8:30 (Non farms release on 11/06/09).
This is a beautiful chart. The picture of money. It is screaming to us all, “here I am come and take me!” but… the price dove 50 pips in 5 minutes. If you wait till the 5 min. candle completes before you enter, fear and uncertainty enters the mind, you think, oh no, where is my stop going to be? all the way at the top of that bar (50 pips)? Gasp! That bar was fast, violent and crashed through support. It CLOSED at the LOW, indicating that prices will continue down (as they did) Unfortunately I am writing this at a time where I cannot go back and capture the one minute (software limits) but the one minute chart had a much more beautiful image and offered far better entries. look at this 15 min chart and the bar in question.
Notice that in this 15 min chart you have significant “follow through” (continuation) but I see a warning sign, do you? I see a bottoming tail on bar 2. In fact I see tails in both directions on the next 6 or 7 bars. Wild, whippy, some 40 and 60 pip ranges. This can be traded multiple times in both directions but you need ALL the charts working in tandem and an understanding of their interaction with each other. Look at this one hour chart. This helps clarify why there was a stall:
On this one hour chart we can see that price has come down towards a prior low which is acting as support. Notice the 3rd 1 hour bar has a HUGE tail, in fact it just managed to break support to shakeout any remaining weak longs and trap anyone who went short on that break. If you look at the 15 min chart you will see at the 11:00 bar is a huge bull bar so big it almost engulfs the prior 3 bars. What does this tell you? That’s right, that drop is OVER. Glance back at the 5 min chart at 10:50 am, a bullish engulfing bar, a perfect 5 min buy setup. That had significant follow through.
How did it all turn out? Well Sunday eve at the time of this writing the market gapped higher, retraced to fill the gap and has just broken out higher still. Here is the one hour chart. We are close to a 100% retracement of the entire move:
My “strategy” if you will, is that of bar by bar analysis in multiple time frames. I watch the 1, 5, 15 & 1 hour charts and I am constantly watching the levels, pivots, support, resistance, etc and so on. I am watching the war and participate by “shooting” (scalping) as often as I can. Just like a sniper. Am I always right? No. Sometimes I do indeed guess wrong and I know when to get out. But I am very willing to “collect inventory” when I am building a position, (put on more size, i.e. doubling up, tripling up, and more if I am confident) I am willing to put on considerable size in the effort to get the best average price. I cannot always pick the exact top or bottom. But with this method it allows me to come very, very close. Not only do I scale in, but I also scale out of positions to ring the cash register and lock some profits in and see where prices go from there. There are rare occasions when I can capture 20, 30 and even 50 pips in a matter of minutes. When that does happen, it is a gift and I almost always take all of it at that point. The amount of lots I am willing to put at risk varies with confidence level which always varies with the charts. They tell me what to do. My strategy is flexible, not rigid. Think of the rigidity of something like Tae Kwon do (karate) and the flowing mastery of Jeet Kun do ( a mixture of martial arts developed by bruce lee). I do not want to be rigid but flowing, and it surely works for me. The charts will talk to you to if you listen and get in tune with them. I would urge everyone who takes trading seriously, and this is very serious business, operating on a patient who is always moving around, to constantly focus your attention on what is happening in the moment and try and put yourself in the mindset of WHAT are traders feeling at any given time point… pain? fear? greed? uncertainty? Now, if you find yourself too uncertain or fearful, it may be best to get out until there is more information, that gives you clarity or confidence. I would also urge traders to make sure that you can see multiple time frames easily on whatever you are trading. I personally use 4 monitors. 4 charts for each currency pair. I also put common ones side by side like the EUR/JPY and GBP/JPY for correlation purposes.
Now, in the very near future I will be taking exact snapshots of charts at the moments that trades are happening. I will write down my analysis of things and go over with you my strategy much more in depth and give a clear understanding of what is happening and why. This (I hope) will be very enlightening to some. My expertise came from stocks and reading the level 2 and figuring out who the axe was and I was actively engaged in the smoke and mirrors tactics that the market makers used (trying to scare the market with false offers, attempting to hold it up with false bids, pulling bids and switching sides to crash a stock as it dropped through the LOD. When I was really short a ton of shares and needed it to drop a point, etc…) I cannot do the exact same thing in forex. Also, I must confess that I am human and do not know everything. I am still figuring some things out. The forex is new to me by about 4 years and it does not work exactly the same way. But the charts are similar, and what I do know WORKS. So, if I mess up and say something false or inaccurate, it is not intentional and I sure do hope someone will correct me if my knowledge is in error in any way. I would love the gaps in my knowledge to be filled in. This is my goal, to help others who might have some gaps. We all need to learn how to put this jigsaw puzzle together so we can see more clearly.
So, consider this in INTRODUCTION to my strategy with much more to come. Better charts and examples I do promise, as well as explanations of the test and retest strategy and (I have to figure a name for this one: ) The “Build a huge cushion of profits in a temporary channel trade, so that I can pile it on big time to make sure I have a cushion for my stop so that I really don’t lose if it goes against me, when I short the heck out of something and its about to crash strategy”. ( oh boy, I’ll come up with a better name latter). Thanks for taking the time to read this, and thanks to Casey very much for helping me with the software! Happy trading.
DESCRIPTION OF TERMS: Just in case anyone doesn’t understand some of the terms I used, here is some clarification:
Headfakes: when price just manages to over take the HOD (High Of the Day), LOD (Low Of the Day) or a prior pivot high or low, by just a few pips and then reversing hard. Basically it it a whipsaw, just chewing traders up.
Short sqeezes: When traders are piled into a particular currency pair short and the price “squeezes” all those that are short. It can be fundamental or news based or not, but when a short squeeze happens, it brings alot of pain as the shorts have to bail out. Price can spike to ridiculous levels, as its like someone yelling FIRE! in a movie theater. Everyone is trying to bail out just one or two doors and its just crazy.
The collection of “inventory” Just like a merchant who stockpiles merchandise when it is exceedingly cheap, market makers, astute traders/ investors will load up when the getting is good. Did you just buy 2 or 3 lots because the price is super cheap at the moment? Price just got cheaper? You liked it alot at 1.4930 and now you LOVE it at 1.4905 time to grab a few more lots because your confidence is VERY high that it is going to retest the 1.50 level in the next few hours or day. This is similar to the dollar cost averaging strategy that investors use on their favorite stock.
Euphoria: price is insane at the moment. We are up 12 straight bars and several hundred pips on the 1 hour charts. We are VERY far from the moving averages and this is just shear madness. So, not only do you sell every last lot you have, but you risk some of those profits and short the market now because you are willing to wait till price pulls back at least to some semblance of sanity. Then you will cover. (always set a stop my friends).
Size: How much you are willing to swing. Some, a half a lot is too much. Others are willing to buy “twenty” (twenty million) I personally do not mind trading 1 to 4 lots, but I sure do get nervous if I have Ten.
Level 2 is an info box that stock traders use to “read the tape” In the older days you could determine who the axe was (the market maker that was doing most all of the trading for a particular stock) When the market maker kept “lifting” the bid (bidding the stock up) and did not stop, you could basically see that he was filling a clients order and you could ride his ‘coattails to profits. But, this quickly lost its significance when they started using arca and island (ECN’S… Electronic comunications networks) to mask and hide their intentions.
The practice of false bids and offers is very commonplace and not illegal. You can never really tell if it is real unless its at the current price and you see the “prints” (time and sales box) going off and the market makers amount he is willing to buy is dropping in accordance with the prints passing by on your screen. Some even “refresh” meaning that 50 thousand shares (lets say) is being sold in a minute or 2 and you can see this, but the market maker holds firm on the bid and keeps refreshing that he is willing to buy more at that price. The false bids are usually several cents down “below the market” and when people want to prop up a stock that they do not wish to fall any further, there can be false bids. But if they start to get whacked. You might see they are bidding for 5K shares, and maybe 2 or 300 go off and they “drop” the bid. Completely back off, cause they didn’t really want it. Making a stock crash when it was in danger of breaking to new lows, some traders would have false bids out there, and when it started to get hit, they would drop the bid, switch sides and then offer to sell 20K shares! scaring the market and making it break, which always triggers stop losses and sometimes you can get 50 cents on 10K shares in a heartbeat.
Level 3 is a screen I wish I had. Market makers can see far beyond NASDAQ “total view” they can see ALL the books and maybe even the dark pools, but of this I am NOT sure, They have a pen that they can just hit the screen and “take people out” meaning when their pen hits the offer, they buy it all and that offer is gone, and price moves up to the next level. Its an amazing thing really. They trade thousands of shares a minute, capturing the spread. Like a kid on speed that has mastered a video game and you say wow, how does he do that!
Capturing the spread. I bid for a thousand shares of ebay at .04 and I am offering it out at .05. The transaction happens. I make 10 dollars. Sounds like no big deal, but to a market maker who does this thousands of times in a 6.5 hour period, well, he buys a new Porsche every week.
O.K. Again, Happy trading to all, Hope this has been a help. Next article will be on the “sell Setup” with specific charts and explanations.
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