With the U.S. equity market again at all time records highs this week, there are already rumors of market bubbles and corrections, questions about the FED actions to ”taper” back QE3, etc. Times like these can certainly lead to fear, anxiety and often leads to our questioning our trading style and methods. Even sleepless nights can result. Sometimes we will alter or bend our rules during uncertain times – tightening up our stops is a common practice among newer traders; however, more seasoned traders understand that tightening up our stops during more volatile times can be the worst thing we can do and can further increase our losses. In fact, doing so can almost guarantee that you will lose on the trade. The thought may occur to us – if we are going to lose anyway, we want to lose less than we would have under normal circumstances. This kind of thinking can lead to a very negative trading psychology in which we may under-trade and miss perfectly good trading opportunities or may lead to chasing successful trades and entering trades too late. The important thing to remember is that we cannot totally eliminate our risk! The only way to absolutely eliminate market risk is to stop trading, but this will also totally eliminate any opportunity to be successful and make any trading profits as well.

The Key to Low Anxiety Trading is to reduce your EXPOSURE to the market.

The best way for a trader to reduce exposure in a volatile market is by reducing position size. Tightening our stops may reduce our potential exposure, but it also increases our probability of taking a loss. So if we are going to reduce our exposure by reducing our position size, and we normally define our risk as 2% per trade, then we may want to consider reducing our exposure per trade down to 1% or lower.

So, if we are feeling anxiety because of current market uncertainty, the best thing we can do is NOT to change our methods or system rules, but simply reduce our position size; therefore, reducing our exposure to the volatility. This will help us control the fear and anxiety that come from trading in times like we are currently experiencing.

Always use a stop loss and always quantify your risk before you make a trade. Nobody likes to take a loss, and I am no different; however, even under uncertain market conditions, like we are experiencing now, by managing your risk per trade, we can reduce our anxiety and still have good trading opportunities. Also, adhere to the “slow and steady wins the race” philosophy of investing and never “bet the farm” on a single trade because there really are no sure deals in life, only the possibility of success if we manage our risk and, thus, protect our trading accounts.

So, when the markets get crazy and uncertain, reduce your risk by reducing your position sizes, which will reduce your anxiety and go ahead– get a good night’s sleep!

New information came out today that states that temporary jobs in the US have increased by 57% but there is a debate, as usual, as to what actually is causing the increase and what the increase actually means. Generally speaking, there are arguments that the increase is due to US corporations becoming more interested in a more mobile work force where they do not have to hire full-time employees; they can hire temporary employees moving them in and out as necessary based on the economy and on company specific needs. Another argument is that the reason for the additional temporary jobs is a reflection of the economy, which is not fully recovered and when the unemployment rate gets back to 5% to 6% employers will have difficulty finding workers and will have to hire full-time people. Some also say that this is directly due to the uncertainly around the Affordable Health Care Act.

Generally speaking, I do not believe that it really matters what the reason for this is or what the result will be. With the events that have played out in Washington over the past several months, I realized that the US government provides us with the best possible reason to trade that I can think of. Through their inefficiency and inability to cooperate with each other they basically render some US citizens powerless to maintain a stable work life, which translates into an unstable income situation or cash flow. Some people that were full-time employees in the past are now part-time employees or they will be part-time employees in the future, which means that many people that couldn’t afford to live on their full-time pay will have to figure out how to live on part-time pay, meaning that many people will need some form of supplemental income. Of course, my thought is that they could supplement their smaller salary with investment or trading profits.

I understand that not everyone wants to be a trader or even an active investor, but learning to trade to provide yourself with an alternate form of income may make some sense. Depending upon a person’s work schedule they can find a way to trade or a style of trading that works for them leaving plenty of time for work, trading and free time. I have been self-employed for the majority of my life so I am very sensitive to the fact that the more streams of income you can develop the more financially secure you will be. Probably the reason that the specific article that presented the temporary job numbers struck a nerve with me is because it is just another reminder of how fragile our jobs and our ability to earn a steady income can be. This situation simply reminds me of how important it is to have multiple streams of income especially income from at least one source that is not dependent upon other people.

When we trade or invest we are making our own decisions based on the information that is available at the time making the best possible choice or decision that we can make, given the current circumstances. We are in control of our own situation and, if we are good enough traders or investors, we can largely determine how much we earn and when we earn it, which means that the craziness in Washington or anywhere else becomes a non-issue. It may be an issue only to the extent that we need to adjust to what the markets believe the situation to be but we can be largely unaffected.

The ability to earn income, regardless of what happens around us, is a good way to buffer ourselves or to get ourselves out of the line of fire when uncontrollable events occur. We do not need to be victims we need to recognize that things are always changing so we may expect the source of our income to change at some point as well. The more income that we can achieve from sources that we directly control, the more stable we will be and the better positioned we will be the next time the government shuts down or when the next bubble bursts, causing the next unprecedented financial crisis.

This week we have seen a pretty strong down move in the price of gold and silver and the markets have seemed to want to push them lower. Take a look at this chart for gold below.

In this chart we are looking at the 1 hour time frame from about the 5^th of November to the 21^st of November and you can see the steep drop in price of gold has taken in a relatively short time frame. Regardless of the instrument that we are trading, when we identify strong moves like this, we need to be biased to the down side and look for opportunities to take short trades. As the price moves down we would want to look for it to retrace back up to areas of support. Take a look at this chart below to illustrate this point.

Here our red line shows the downtrend of gold while the first green line shows the retracement that occurred about a week ago. This retracement would be the area where we would be looking for a possible short entry. The last green arrow shows what we would be looking for currently in order to look for a short entry trade. We don’t know if it will do this or not but we should be watching for this possibility.

Another possible trade setup might be to look for a breakout during a sideways move. Take a look at this chart below to see this more clearly.

In this chart we are looking at the 5 min. time frame and it is showing a sideways type of consolidation. The red line could represent the area of resistance while the green line is showing the area of support. The trade entries could occur as the price moves above or below these lines. If the price broke below the green line support we would be entering a short position by using a sell stop order to enter in the direction of the trend. If the price breaks above the red resistance line we would look to enter with a buy stop order to try and catch the retracement move back up again.

So currently with the chart of gold we can look for a couple of possibilities for trades. The first would be to take a longer-term approach and wait for the price to retrace back up to the downward trend line on the longer-term charts. Then enter as the price moves back off the resistance line as a short trade entry. Another possible entry would be to look at the shorter term and wait for the breakout to occur like we describe above.

Regardless of how you trade, you will have opportunities to take advantage of the movement and volatility happening in the metals market currently. With the bigger moves comes the possibility for bigger losses if we are not using proper risk management so make sure you always use stop losses and keep your risk at a maximum of 2% per trade.

Recently, I discussed using flag and pennant price patterns to identify a continuing or ongoing trend in the market. Now, the next logical question: Is it possible to look for price patterns that would help to identify or predict a CHANGE in direction from a current trend?

There are some time-tested price patterns which can help to identify a market shift from the current trend. These patterns are often referred to as Reversal Patterns. While these patterns do not always show up in every market reversal, when they do show up, they are very powerful indicators of a weakening trend and a possible reversal. These reversal patterns are very dependent on support and resistance levels.

Double Tops and Double Bottoms

First we will start with Double Tops and Double Bottoms. These are also sometimes referred to as an “M” pattern for the double top and a “W” pattern for a double bottom. A good example of a double bottom or “W” pattern can be found in the current chart of the AUD/USD Forex pair.

Figure 1: Double Bottom or “W” pattern on the Daily AUD/USD Forex Pair

Triple Tops and Triple Bottoms

In addition to the Double Tops and Double Bottoms we have a similar pattern, Triple Tops and Triple Bottoms, that, when it sets up, can be a very strong indication and even stronger than the Double Tops or Double Bottoms. A good example of a Triple Top is also found on the AUD/USD forex pair in the following chart. Note that once the support level at the bottom is broken after three attempts of the price action to move higher, and it just doesn’t have enough momentum to move higher, will often reverse and move lower.

Figure 2: Triple Top with price breaking below support

Head and Shoulder Patterns

At the top or bottom of the market, you can see a head and shoulders patterns, like the chart below on the EUR/USD. The pattern found in Figure 3 is referred to as an Inverted Head and Shoulders pattern because it is found at the bottom of a market in a down trend and is opposite of the Head and Shoulders pattern found at the top of a market. It is also similar to a Triple Top or Triple Bottom, but the middle peak is higher or lower, setting up the head and with the two shoulders and the neckline as illustrated.

Figure 3: Inverted Head and Shoulder

Conclusion

These three types of reversal price patterns are very useful for helping traders identify potential market reversals. It is very important to understand how these patterns rely on long established principles of support and resistance. As illustrated in the charts, for the pattern to be complete, the price action completed and confirm the pattern by breaking up or down through support at the top of the market or up through resistance at the bottom of the market.

Traders Challenge: Look for these patterns on your charts and see how often they indicate a serious trend reversal or at least a significant weakening of the current trend.

Today we are going to look at the quick moves that happened on gold as the European Central Bank came out with their release of the Minimum Bid Rate. This came out 45 min. after the Bank of England kept their interest rates at the same 0.50%. The ECB had their interest rates at a low of 0.50%, which was where the forecast had them keeping it. When the number was released the ECB decided to lower the interest rate to an all-time low of 0.25%. As you might expect, this surprise reduction in the interest rates caused the Euro, as well as gold, to react very quickly and strongly.

Whenever we have central banks discussing interest rates, we need to be prepared for the possibility of big moves. Knowing this we should take precautions with the amount of risk that we trade during these times. If you normally are risking 2%, you may want to consider dropping it to 1% during the times when the market may be more likely to see this type of volatility.

In the chart below you should notice that the movement prior to the release of the minimum bid rate was very flat, but when the announcement came we saw a quick move up, followed by a significant move back down. This is the type of move we see when the news comes out different than what was expected with the forecast.

This move in gold is seen on a 5 min. chart. Often times this shorter time frame can be deceiving because it will make the move look bigger than it really is, but by looking at the hourly chart below you will see that it was a fairly significant change. Today there was a big $25 plus move that happened.

The question now is, what will happen going forward? Does this move indicate the beginning of a longer-term move down or will it be volatile for a bit then end up where it began? This, of course, cannot be known until the movement actually happens. The thing we need to worry about is how we approach our trading after this type of movement. Regardless of whether it goes up, down, or sideways we should know what our trading approach will be.

One approach would be to try and take advantage of the choppiness that can happen after the news by looking for short-term scalping opportunities. This would mean we are looking for quick moves to get in and out of the trades. Another approach would be to look for a reversal of the move down. Often times, the price will move back in the direction it came down from and we can take advantage of these reversal moves. Maybe the simplest approach would be to avoid trading it all together. This way you avoid the possibility of getting caught on the wrong side of the trade.

Take some time to review your process for trading during times of possible volatile news announcement. Also, make sure you know how you will trade if you decided to try and trade these announcements.

I discussed some basic Japanese candlestick patterns recently, which included ones like doji and engulfing patterns. These are some of the most basic reversal patterns to identify areas of indecision and potential reversals in the market. Today, I would like to discuss some additional reversal patterns that add to our knowledge of Japanese candlesticks.

1. Shooting Star Pattern

The Shooting Star is a BULLISH trend reversal pattern, meaning this pattern will be found at the bottom of a down or bearish trend. It is associated with a trend reversal from a short trend to a long trend or Bearish to Bullish. In the diagram above, you will notice that it has a small body at the bottom of the candle and a longer wick or shadow on the top of the candle with no lower wick or shadow beneath the candle body. The long upper wick or shadow indicates the bull’s inability to close higher and the bear’s rejection of the bullish trend. It is not important to the shooting star whether it is an actual bull candle or bear candle, either one tells the same story. This pattern indicates in a downtrend the loss of momentum to the down side and, perhaps, a potential reversal to the upside.

2. Hammer Candlestick Pattern

The Hammer Candlestick pattern is a BEARISH trend reversal pattern, which is the opposite of the Shooting Star. As illustrated in the picture above, the shooting star has a small body on the top of the candlestick and a longer wick on the bottom of the candlestick. It indicates a potential reversal in a bearish down trending market to a bullish uptrend. The long shadow indicated the bear’s inability to close lower and the bull’s rejection of the bearish trend. Also, as with the shooting star pattern, it does not matter if the actual candle is a bearish or bullish candle, it is the wick and body relationship that is important.

2. Evening Star Candlestick Pattern

The Evening Star pattern is a bearish reversal pattern consisting of 3 bars in an up-trending market. As illustrated in the picture above, the first candle is a long-bodied, bullish candle extending the current uptrend. The second candle is a short, middle candle that gapped up in the open. The third candle is a bearish, long-bodied candle that gapped down on the open and closed below the midpoint of the body of the first candle. If the pattern is found in a strong uptrend, it may be a very good indication of severe weakening of the uptrend and potential reversal.

4. The Morning Start Candlestick Pattern

The Morning Star is the opposite of the Evening Star and is a Bullish reversal pattern, which occurs at the bottom of a market. As illustrated above, the pattern consists of three candlesticks in a down trending market. The first candle is a long-bodied, bearish candle extending the current downtrend, the second candle is a short, middle candle that gapped down on the open, and the third candle is a bullish, long-bodied candle that gapped up on the open and closed above the midpoint of the body of the first candle.

These 4 candlestick patterns are very good indicators of a change in market sentiment and, if they are present at either the tops or bottoms of the market, they indicate a very good possibility of a change in momentum in the market. Look for these patterns and identify any possible reversals in the charts that you follow.

As always – Good Trading!

I’m a huge believer that the more you look at a chart, the more you’ll see. In fact, I tell that to people all the time. Some people have responded to that statement by telling me that they believe that sitting around looking at charts is like watching paint dry, but I still believe that the more you look at them the more you will be able to identify repetitive patterns that develop. The more time you spend watching charts, the easier it is to see these patterns develop and you will be able to spot them earlier and earlier in their development, which, of course, makes it easier to enter the market at good prices.

Getting into a trade at a good entry price really isn’t that difficult to do. When you enter the market, generally speaking, there is a 50/50 chance that you are correct; the trades that you were wrong on will hopefully get stopped out quickly with as little damage as possible, and the trades that you use a profit target on will hopefully reach that profit target, so you don’t need to do much at all. At that point, you are simply waiting for either the profit target or the protective stop to be reached. One way or the other, you’re out of the trade with minimal effort after it is initially set up.

Everything mentioned above is pretty easy and very straightforward for most people. But what isn’t always easy is the actual management of a successful trade when we are not using a specific profit target and when we are trying to maximize the profit of a particular trend – how do we manage those trades? It is very easy to come up with ways to manage trades in longer trending markets and it is really easy to come up with ways to manage past trends when we are back testing. The difficulty for many traders comes when we try to come up with a consistent way to manage all or most of the longer-term trades. When back testing the management of longer-term trades it is usually pretty easy to find the optimal way to manage a specific move. This is regardless of if it is with a trailing stop, an exit when a specific event occurs around a set of technical indicators. What is not easy is to find is the consistently best way to manage all of the trending trades to maximize profits.

Using some type of trailing stop is a very common way to manage longer-term positions, but if the market spikes or gaps and recovers you can be out of the trade in an instant before seeing much profit at all; if the trend recovers you have likely missed most of the move. If you use a specific profit target, which can be a low stress way to manage trades, if the profit target is not reached and the price action turns around, you may give up most or all of your unrealized profit, meaning, of course, that all you did was ride the price up and then back down again. If you do have a profit target that is reached you will book a predetermined amount of profit. But what happens when the trend continues for an extended period of time beyond our profit target? Do we watch the trend as it continues counting all of the profit that we are missing out on? What if we exit when a faster average crosses over a slower average, or when the stochastic %k crosses %d, or when the MACD crosses over? Regardless of any of this, whatever way it is that we choose to exit our trades there is no one way that is perfect in all situations. Applying one exit strategy to all types of trends will work great sometimes, but sometimes it will either not capture enough of the profit that is in a given trend or we may give back too much before the exit is actually triggered.

It is possible that the best way to manage a longer-term trade is by having several different ways to do so based on how a given trend develops. The more you watch the charts the more likely it is that you may be able to get an idea of how the price action is likely to move which will allow you to employ the type of trade management that best suits the specific trend. The price action of some trends can be very spiky showing long wicks on both ends of the candles or bars, sometimes the long wicks will be in the direction of the trade meaning that the other end of the candles or bars are flat and relatively easy to predict going forward, some trends will move in a very deliberate way while others are very erratic. My experience in observing charts tells me that there really isn’t one best way to manage all longer-term trades so using the best form of trade management for the trend that develops may make the most sense. Regardless of what management style is chosen it still comes down to watching the charts and having discipline, which will make managing longer-term trends much easier and as profitable as possible.

After seeing the gold market be fairly deliberate and consistent in how it has been moving lately the past couple of weeks we have seen a bit more volatility in how it’s moved. Although we like to see deliberate moves, we can also find some good trading opportunities when the market is a bit more volatile. Historically gold has gone up in price, so as we see the price move down, we may want to look for opportunities for placing long trades. Let’s take a look at the weekly chart of where gold is currently sitting as of November 14, 2013.

The first thing to notice is that the price is currently experiencing a fairly significant drop down or pull back from the past highs. This chart covers the last 5 years where we see the last high back in 2009, after which we have seen it drop in price. At some point we will see the support kick in and the price begin to move back up again. When this will happen is anyone’s guess but we should be looking for the signs of a bottom being put in. Currently, we are not seeing this but are watching for it to happen. Now let’s take a look at the daily charts to see what is happening.

As we discussed before, the price of gold has been a bit more volatile over the last while, we even saw a gap in the price a few days ago. Whenever there is a gap in price we need to approach the market cautiously as you may find the price action being less deliberate. Finally, we will look at the 1 hour chart so see the shorter-term view of gold.

In this chart you can see the gap a bit closer. Often times when a gap occurs we will see it fill back at some point. This can happen quickly or it will take some time. You can see that the lower line is where the price gapped down to and is often times the area where there may be some resistance as the price begins to move back up again. The area in between the lines is kind of a zone where the price can get stuck in and until it moves out of this area we may find continued choppy and non-deliberate price action. We will want to wait until price moves out of this area in order to see a more tradable market.

As we take a long-term view on gold we generally will approach it with the idea that price will increase over time. This does not mean it won’t go down in price but when it does it gives us a good price to look to enter our long positions. On the shorter-term time frame we are seeing the market being a bit more volatile and choppy which might indicate that the price may be trying to find a bottom on the longer-term. We will still want to wait for confirmation but we want to start to think about this occurring at some point in the future.

It seems that the last several weeks, one day the market is up and the next day it is down, reacting to positive or negative news stories generally concerning the Federal Reserve’s “tapering” plans. Many traders are feeling the anxiety that comes from the currents ups and downs of the market. The first thing to understand and remember is that there is NO such thing as a perfect market! In fact the market often cycles through periods of deliberate trading vs. non-deliberate trading periods. Certainly non-deliberate trading times are more volatile and can increase our risk. Non-deliberate trading markets are defined in general as a market with the last 20 periods with unusually long candlewicks, wider ranges, trading gaps, etc. Generally speaking a more deliberate trading market will have no unusually wide trading days, with no unusually long candlewicks or unusual trading gaps.

See Figure 1 below for an example of a non-deliberate market and note the up ranging patterns, wider candles, gaps etc.

Figure 1: Non-deliberate market

Figure 2: Deliberately trading market

Note that in Figure 2 – a deliberately trading market, the nice trend, narrower bars and lack of long wicks and gaps. Now we would all prefer to only trade when the market is more deliberate. There is no doubt that during these non-deliberate times of market uncertainty, these can negatively affect your trading psychology or mind-set leading to fear and anxiety over your trading style and methods. Certainly there are times, like the present, when the market is more uncertain or non-deliberate than you would want. But, if we allow the market to get into our heads, you can really find yourself overly anxious and even too discouraged to trade.

However, if you have a good trading method, but start to question the trading methods, every time you have a loss, you may decide that it is better to sit on the sidelines and not trade at all missing many good trading opportunities. One thing that traders, especially new traders, do during uncertain times, like we are in currently, is to tighten up stops; however, more seasoned traders understand that tightening up our stops during more volatile or rangy times can be the worst thing we can do. In fact, doing so can almost guarantee that we will lose on the trade. The thought is if we are going to lose anyway, we want to lose as little as possible. This kind of trading attitude may allow our fears to overcome logic and will lead to more unsuccessful outcomes.

The only real way to reduce our risk is to reduce our EXPOSURE. The best way for a trader to reduce exposure in a non-deliberately trading market is to reduce position size. Tightening our stops may reduce our potential exposure, but it also increases our probability of taking a loss. So if you are going to reduce your exposure by reducing your position size, and you normally define your risk as 2% per trade, then you may want to consider reducing your exposure per trade to 1% or even .5%.

In conclusion, if you are feeling anxious or discouraged because of current non-deliberate market, the best thing you can do is to NOT change your methods, but simply reduce your position size; therefore, reducing exposure to the non-deliberate volatility. This will help to control the fear and anxiety that comes from trading in times like we are currently in and lower anxiety will help you sleep better at night.

With the Veterans Day holiday this week and with some big holidays coming up in the next couple of months, I thought we would discuss a bit about what can happen to the markets during these times. This is something that we deal with almost every month, there is a holiday and the market or banks are closed. With a holiday either the banks will be closed, the market will be closed or both will be closed. With the Veterans Day holiday this week, the market was opened but the banks were closed. For the upcoming Thanksgiving and Christmas holiday both will be closed.

So what happens to the Forex market when there is a holiday? Well there are several things that we want to watch for. First, we need to see what is going to happen to the Forex market as far as closures go. Very rarely will the Forex market actually close. Even if the stock market is closed, the Forex market is likely to still be trading. You will want to speak with your specific Forex dealer to see the days and times the Forex market will be closed. This generally only occurs during major holidays, but check to make sure.

Second, you will want to be aware of how the market trades during these times. If the Forex market is open during the holiday you will generally see it respond in one of two ways.

1. The market will become very flat.
2. The market will become very volatile.

These results of holiday markets are generally due to the fact that there are fewer traders causing the market movements. This is known as an illiquid market or a market that lacks liquidity. The Forex market is known for the high level of liquidity, which allows for quick trading and tight spreads. When the liquidity is not there, these things become out of whack and the market responds in an unusual way. There are of course many other reasons why the market may be flat or volatile but we should expect this type of movement especially during the holidays.

The market will become flat because the number of traders trading just doesn’t have enough power to push the market in a direction. This causes prices to fluctuate in a tight range during these times. The market may begin to show signs of high volatility during these times if only a few traders begin to do a lot of buying and selling. The few numbers of traders can then cause the larger fluctuations in range of trading for the day.

So how do we approach the market when there is a holiday? Well, the simplest thing to do is avoid trading and enjoy the holiday but if you are determined to trade during these times you should at a minimum lower the risk you are taking in your trades. If your normal risk is 2%, consider lowering it to 1%. Something that will allow you to trade while taking into consideration to potential changes that can happen with the holiday trading.

Take some time to review your process for trading during these time so you can avoid the potential added risk over a holiday.