Short lived momentum reversal trading system

I hope you have seen a lot of times some currency pair, stock or commodity rally (or go down) one day and then reverse the next day and end up at the very place where it started the rally (or move down). This kind of price action is very common in financial markets and they have a clear reason behind this as well as a way to trade this and make nice profits. Today I want to talk about the way you can trade this short lived momentum when prices reverse after a move that is usually driven by some fundamental news. 

If you want to make extra money and are ready to trade Forex, futures, indexes and stocks I recommend Etoro. 

http://www.etoro.com/A41516_TClick.aspx

If you like trading Forex news I recommend watching a video below before you continue with the post:

A much better than expected news might trigger an immediate rally upwards, but if that piece of news does not really add to the longer term change for the positive in a currency, stock or a commodity that rally will be short lived and a reversal will ensue the same day or the next one and the security will come back the exact distance it went on the heat of the news to the very place (price level) where the rally started. Only those pieces of news that have longer term impact cause price leave there current ranges and go to new levels without looking back for a considerable period of time. The price may come back to the level of breakout, but if the reason for price move has very strong reason behind it, the price will continue its’ course sooner rather than later. 

Short lived collapse in New Zealand dollar

However, there are a lot of short lived momentum moves each month and even week that you can capitalize on. Let us look at a few examples now. The first example is with New Zealand dollar. On the 13^th of March (2013) there was an important event for the kiwi. It was interest rate decision. That is a very tradable event and prices can move severely when the news comes out. That is exactly what happened this time. If you look at the chart below you will see the gap on the chart (down) as the kiwi collapsed after the news hit the wires. However, you can also see that the reaction to the news was really short lived and nzd/usd pair reversed the next day and continued going up on the third one when it reached the point when the pair started collapsing. Everything that was lost when the news came was gained back as the market digested the impact it may have for the future.

We do know that the chief of the Central Bank of New Zealand made some dovish comments regarding the rate of the kiwi and his willingness to see it significantly lower. We know that this kind of action can purely be attributed to the so called ‘currency wars’ which is a prevalent theme in the markets nowadays. However, as most of Central Banks are trying to do the same the market starts ignoring this game and pays more and more attention to the real economic numbers rather than ‘currency wars’ type of talks. 

So, when you see a currency pair or commodity or a stock go down (or up) watch what happens the next day. Be ready to see a reversal if the reason behind the move was not a strong driver. 

Data that has longer term impact causes prices to continue in the same direction next day

A completely different picture can be seen when New Zealand GDP numbers were released. Much better than expected number created a move that was not followed by a reversal next day, but did continue. This news has much bigger impact on the markets than some fundamental data which is very changeable (like retail sales) and may not have long term impact on the economy. So, if a reversal does not take place after the strong move you may expect and also trade a continuation of the move. 

Short lived Euro collapse after news from Cyprus

Another case of a short lived momentum move is based on the most recent trouble in EU – the Cyprus case. If you remember the action that Cyprus took when it decided to tax all accounts in order to secure a ten billion Euro loan from Europe. The market was shocked by the news and Euro open with a gap down after the weekend on Monday (17^th of March 2013). 

Let us look at eur/jpy price action for the event. Market gaps down around 300 pips on the open. However, Monday came and market went back where it came from wiping out all the Euro losses on the news. Why? Because market expects the problem will be solved in the nearest future. Yes, I do believe the problems in Euro zone will become uncontrollable at some point and some countries will face bankruptcies, but market does not look that far and it is ready to take risks as bigger profits are where bigger risks are. So, do not be surprised by seeing such illogical price actions in the market when one day you have a huge collapse and then a reversal that pushes the price to exactly the same level where it came from. These kinds of news have short lived momentum. You need a bigger catalyst for prices to continue dropping beyond initial news announcement. 

It is much more important whether the Central bank of Europe increases its’ stimulus like the FED does or not. Of course, if this kind of action (as Cyprus did) was done by Spain or Greece market would have reacted more wildly and that could have led to more prolonged collapse in Euro, but as long as no country in EU announces its’ bankruptcy these kind of events will have short term impact and you can always trade reversals next day. 

P.S. I do think that Euro has run its’ course and will collapse soon, especially against Japanese Yen. So, watch Yen pairs, because a trend can change any time now as those fail to take previous peaks for some time. 

So, I hope you understand now why we see such illogical choppy price actions regularly in financial markets and you do know how to trade them.

Ok. I hope you benefited from the post. If you liked the post I would also be happy if you gave a plus on Google+, tweeted, liked it on Facebook and other social platforms. Have a nice day. 

Vytas.

If you want to make extra money and are ready to trade Forex, futures, indexes and stocks I recommend Etoro. 

http://www.etoro.com/A41516_TClick.aspx

See also my previous post: How to make money in trading breakouts

Disclaimer

Trading financial markets carries a high level of risk, and may not be suitable for all investors. All information on the blog http://trend0.blogspot.com/ is of educational nature and cannot be considered as advice, recommendation or signals to trade in any financial markets.

How to make money in trading breakouts

Breakout trading strategy is probably one of the best known in financial community of technical traders. When used properly it can increase your chances of making significant amounts of money on a monthly basis. This trading system is in my trading arsenal on a regular basis and I recently made some nice cash by trading a breakout in Gold. Various breaks happen quite often even daily in various securities. We, however, want to find the best opportunities that can give us the biggest rate of return with the smallest amount of risk. Let us look today at the way one can trade breakouts. 

I also encourage you to watch a video on calm trend trading strategy. All trends start with a breakout and the video just expands the topic of the article:

What kind of breakouts to trade?

Breakouts happen daily on various time frames: weekly charts, daily charts, hourly charts and most often on various minute charts. The smaller time frame the more false breakouts you have. Therefore, I tend to avoid minute type of breakouts and concentrate on breakouts on daily charts. Of course, you can clearly see those on 4 hour or 8 hour charts too. I like to go through various time frames at the end of the day to see whether some securities are ripe for a breakout or I need to concentrate on other ways to trade the markets. 

Necessary condition for a breakout

Breakouts occur when price move out of ‘congestion areas’. These are very tight ranges with prices moving within very limited range for a couple of days or a week. These congestion areas are often formed when security loses momentum after some prolonged swing or a short term trend and the move stalls. In these kinds of ranges we look at the low and the high of prices and mark these as possible breakout areas. When broken after some news or simply technically one can expect a strong move and should be ready to place buy or sell orders depending on whether the breakout occurs upwards or downwards. 

These kind of breakouts are sometimes corrections of a prevailing swing or trend and the price often moves against the trend that had previously been pushing prices. I dare to trade these breakouts against the prevailing trend. Although one should concentrate on a prevailing trend and trade in the direction of it, there are choppy trends that can provide you with both opportunities to trade with the trend and against it. 

Breakouts in GOLD

The most recent examples are from my two trades in GOLD. The first breakout occurred in the direction of a prevailing trend (downtrend). In the beginning of February (1^st through 11) Gold got into a congestion area of 1684-1661per ounce. By looking at shorter time frames I understood during the weekend that the break low will occur probably on Monday and I entered a short order below 1663 level (a little above than the low of the congested area) as I did expect the collapse will get momentum falling even before the low of 1661 was reached. Any time the price rose trying to go through the upper level of the congestion it was met by strong bearish pressure, which can be clearly seen from 4 or 1 hour candles of that period. Bulls got weaker and weaker and for any experienced technical analyst it must have become clear that the path of the least resistance in GOLD at that period was DOWN. Unfortunately, I expected the commodity to stay in its’ ‘then’ range and bounce from 1630 level. This did not happen as the price of the metal collapsed through the floor and went as low as 1555 level. So, I took my profits at 1.6550 level (13 bucks per ounce profit). Well, what a move (extra 100 buck down) missed! However, I still made nice cash. I saw the congestion, bet on its’ break and was rewarded for successful speculation. So, can you!

If you want to make extra money and are ready to trade Forex, futures, indexes and stocks I recommend Etoro.

http://www.etoro.com/A41516_TClick.aspx

The second congestion occurred on March 1-11 as GOLD was 1587-1564 range. Looking at the congestion on 4 and 1 hour chart and inspecting the price action it became quite clear that the commodity found strong fresh buyers and GOLD would run up soon. Now, the chart below is not really what I have on my trading platform. Below you can see the price going through the resistance level and falling back on the 7^th of March. It did not really happen until the 12^th of March (check other charts I cannot upload the one on my platform as it does not have copy function). So, the price stayed within the cage of the above mentioned boundaries till the break up on Monday of March 12. 

Study 4 and 1 hour candles and see how falling to the lower part of congestion area bullish candles emerged indicating that strong buying picked up. Trust this kind of price action as it often shows that bigger move is coming. In the second situation the break upwards was short lived, but it was still a nice move and I significantly increased my account by trading the breakout. I exited a few bucks before the critical 1600 level as I saw price stalling. 

Exits

The standard take profit area can be measured by calculating the height of a congestion area and adding the amount to the breakout area. However, from time to time the target is not reached and you can trail your stop by moving it below/above (depending on which direction the market goes) 1 or 4 hour candles until you knocked out of your trade. Alternatively you can open a few trades and close the first one as soon as it shows some profit and leaving the second one to go with the market till your stop is knocked out (it maybe below/above 1, 4 hour or 1 day candles). If the move is very strong you can stay longer in the market. I missed it with my first trade. Anyways, do not allow your profits to become losses in any of your trades. 

So much for breakout trading strategy! Hope to write soon on the subject as we have a pretty interesting week ahead of us with FOMC rate decision and a few other very interesting risk events.

Ok. I hope you benefited from the post. If you liked the post I would also be happy if you gave a plus on Google+, tweeted, liked it on Facebook and other social platforms. Have a nice day. 

Vytas.

Disclaimer

Trading financial markets carries a high level of risk, and may not be suitable for all investors. All information on the blog http://trend0.blogspot.com/ is of educational nature and cannot be considered as advice, recommendation or signals to trade in any financial markets.