Candlestick GBP/USD

Breakaway bullish

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Bearish breakaway (1)

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Bearish breakaway

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Bullish Belt Hold (4)

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Bullish Belt Hold (3)

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Bullish Belt Hold (2)

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Bullish Belt Hold

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Bearish Belt Hold (2)

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Bearish Belt Hold (1)

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Bearish Belt Hold

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Trend Reversal formations

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Double Top

Happens after an extended uptrend.
Formed by 2 peaks that can’t break a certain level. This level becomes a resistance line.
Place our short entry order below the low point of the valley in between the 2 peaks.

Double Bottom

Happens after an extended downtrend.
Formed by 2 valleys that can’t break a certain level. This level becomes a support line.
Place our long entry order above the high point of the peak in between the 2 valleys.

Head and Shoulders

Happens after an extended uptrend.
Formed by a peak, followed by a higher peak, and then another lower peak. A neckline is formed by connecting the low points of the two troughs or “valleys”.
Place your short entry order below the neckline.
We calculate our target by measuring the distance between the high point of the head and the neckline. This is the approximate distance that the price will move after it breaks the neckline.

Reverse Head and Shoulders

Happens after an extended downtrend.
Formed by a valley, followed by a lower valley, and then another higher valley. A neckline is formed by connecting the high points of the 2 peaks.
Place your long entry order above the neckline.
We calculate our target by measuring the distance between the low point of the head and the neckline. This is the approximate distance that the price will move after it breaks the neckline.

Head and shoulders

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A head and shoulders pattern is also a trend reversal formation. It is formed by a peak (shoulder), followed by a higher peak (head), and then another lower peak (shoulder). A “neckline” is drawn by connecting the lowest points of the two troughs. The slope of this line can either be up or down. In my experience, when the slope is down, it produces a more reliable signal.

In this example, we can visibly see the head and shoulders pattern. The head is the 2nd peak and is the highest point in the pattern. The two shoulders also form peaks but do not exceed the height of the head.

With this formation, we look to make an entry order below the neckline. We can also calculate a target by measuring the high point of the head to the neckline. This distance is approximately how far the price will move after it breaks the neckline.

You can see that once the price goes below the neckline it makes a move that is about the size of the distance between the head and the neckline.

Candlesterling

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Candlesticks are formed using the open, high, low and close.

If the close is above the open, then a hollow candlestick (usually displayed as white) is drawn.
If the close is below the open, then a filled candlestick (usually displayed as black) is drawn.
The hollow or filled section of the candlestick is called the “real body” or body.
The thin lines poking above and below the body display the high/low range and are called shadows.
The top of the upper shadow is the “high”.
The bottom of the lower shadow is the “low”.

Long bodies indicate strong buying or selling. The longer the body is, the more intense the buying or selling pressure.
Short bodies imply very little buying or selling activity. In street forex lingo, bulls mean buyers and bears mean sellers.
Upper shadows signify the session high.
Lower shadows signify the session low.
Candlesticks with a long upper shadow, long lower shadow and small real bodies are called spinning tops. The pattern indicates the indecision between the buyers and sellers Marubozu means there are no shadows from the bodies. Depending on whether the candlestick’s body is filled or hollow, the high and low are the same as it’s open or close. Doji candlesticks have the same open and close price or at least their bodies are extremely short.
The hammer is a bullish reversal pattern that forms during a downtrend. It is named because the market is hammering out a bottom.
The hanging man is a bearish reversal pattern that can also mark a top or strong resistance level.
The inverted hammer occurs when price has been falling suggests the possibility of a reversal.
The shooting star is a bearish reversal pattern that looks identical to the inverted hammer but occurs when price has been rising.

Glossary And Foreign Exchange Terms (H-N)

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Harami bar A "wait-and-see" two-day candlestick combination. It consists of two consecutive ranges having opposite directions, but it does not matter which one is first. The second day's range results fall within the previous day's body.
Head-and-shoulders A bearish reversal pattern that consists of a series of three consecutive rallies, such that the first and third rallies (the shoulders) have about the same height and the middle one (the head) is the highest. The rallies are based on the same support line, known as the neckline. When the neckline is broken, the price target is approximately equal in amplitude to the distance between the top of the head and the neckline.
Hedging A method used to minimize or eliminate the risk of exchange rate fluctuations.
High-low band A band created by two winding parallel lines above and below a short-term moving average that borders most price fluctuations. The moving average is based on the high and low prices. The resulting two moving averages define the edges of the band. A close above the upper band suggests a buying signal and a close below the lower band gives a selling signal.
Hoshi (star) A "wait-and see" two-day candlestick combination. It consists of a tiny body that appears the following day outside the original body. It is not important whether the star reaches the previous day's shadows. The direction of the two consecutive ranges is also irrelevant.
Households survey Consists of the unemployment rate, the overall labor force, and the number of people employed.

Implied volatility Method of measuring volatility by considering the premiums currently trading in the market and calculating the figure based on the level of the option premium.
In-the-money (ITM) call A call whose present currency price is higher than the strike price.
In-the-money (ITM) put A put whose present currency price is lower than the strike price.
Industrial Production An economic indicator that consists of the total output of a nation's plants, utilities, and mines.
Initiation margin A margin paid by the trading party in order to trade currency futures. A trader's daily loss cannot exceed the size of this margin.
Interest rate risk Amount of mismatches and maturity gaps among transactions in the foreign exchange book.
International Fisher effect Theory holding that investors will hold assets denominated in depreciating currencies only to the extent that interest rates are sufficiently high to balance the expected currency losses.
International Monetary Market The major currency futures and options on currency futures market in the world. It is a division of the Chicago Mercantile Exchange in Chicago.
Intrinsic value The amount by which an option is in-the-money. In the case of a call, the intrinsic value equals the difference between the underlying currency price and the strike price. In the case of the put, the intrinsic value equals the difference between the strike price and the present currency price, when beneficial.
Inverse head-and-shoulders A bullish reversal pattern that consists of a series of three consecutive sell-offs. Among the three consecutive sell-offs, the shoulders have approximately the same amplitude, and the head is the lowest. The formation is based on a resistance line called the neckline. After the neckline is penetrated, the target is approximately equal in amplitude to the distance between the top of the head and the neckline.
Irikubi A bearish two-day candlestick combination. It consists of a modified atekubi bar. All the characteristics are the same, except that the second day's closing high is marginally higher than the original day's low.
Island reversal An isolated range or ranges that occur at the tip of a V-formation.
ISO codes Standardized currency codes developed by the International Organization for Standardization (ISO).

J-Curve theory Devaluation of a currency will trigger export gains in the long term, rather than the short term, because of previous contracts, existing inventories, and behavior modification.
Jittai Body of the candlestick (See Candlestick charts.)
Journal of Commerce Index Index that consists of the prices of 18 industrial materials and supplies used in the initial stages of manufacturing, building, and energy production. It is more sensitive than other indexes, as it was designed to signal changes in inflation prior to the other price indexes.

Kabuse (dark cloud cover) A bearish two-day candlestick combination. It consists of a second-day long black bar that opens above the high of the previous day's blank bar and closes within the previous day's range (in an uptrend).
Karakasa (hangman at the top, hammer at the bottom) A bearish candlestick at the top of the trend, bullish at the bottom of the trend. The candlestick can be either blank or black. The body of the candlestick is very small and only half the length of the shadow.
Kenuki (tweezers) A "wait-and-see" two-day candlestick combination. It consists of consecutive bars that have matching highs or lows. In a rising market, a tweezers top occurs when the highs match. The opposite is true for a tweezers bottom.
Key reversal day The daily price range on the bar chart of the reversal day fully engulfs the previous day's range; also, the close is outside the preceding day's range.
Kirikomi A bullish two-day candlestick combination. It consists of a blank marubozu bar that opens the second day lower (than the previous low of a long black line) and closes above the 50 percent level of the previous day's range.
Knockin A plain vanilla option that does not exist until the trigger is reached. Knockout a plain vanilla option that goes away if the trigger is reached.
Koma (spinning tops) A reversal candlestick formation that consists of a short bar, either blank or black. This candlestick may also suggest lack of direction.

Larry Williams %R A version of the stochastics oscillator. It consists of the difference between the high price of a predetermined number of days and the current closing price; that difference in turn is divided by the total range. This oscillator is plotted on a reversed 0 to 100 scale. Therefore, the bullish reversal signals occur at under 80 percent and the bearish signals appear at above 20 percent. The interpretations are similar to those discussed under stochastics.
Leading Indicators Index An economic indicator designed to offer a six- to nine-month future outlook of economic performance. It consists of the following economic indicators: average workweek of production workers in manufacturing; average weekly claims for state unemployment; new orders for consumer goods and materials (adjusted for inflation); vendor performance (companies receiving slower deliveries from suppliers); contracts and orders for plant and equipment (adjusted for inflation); new building permits issued; change in manufacturers' unfilled orders for durable goods; change in sensitive materials prices; index of stock prices; money supply, adjusted for inflation; and the index of consumer expectations.
Line chart The line connecting single prices for each of the time periods selected.
Linearly weighted moving average A moving average that assigns more weight to the more recent closings.
Long legged shadows' doji A reversal candlestick formation that consists of a bar in which the opening and closing prices are equal.
Long straddle A compound option that consists of a long call and a long put on the same currency, at the same strike price, and with the same expiration dates. The maximum loss for the buyer is the sum of the premiums. The upside break-even point is the sum of the strike price and the premium on the straddle. The downside break-even point is the difference between the strike price and the premium on the straddle. The profit is unlimited.
Long strangle A compound option that consists of a long call and a long put on the same currency, at different strike prices, but with the same expiration dates. The profit is unlimited.

Ml Money supply measure that is composed of currency in circulation (outside the Treasury, the Fed, and depository institutions), traveler's checks, demand deposits, and other checkable deposits [negotiable order of withdrawal (NOW) accounts, automatic transfer service (ATS) accounts, etc.].
M2 Money supply measure that consists of Ml plus repurchase agreements, overnight Eurodollars, money market deposit accounts, savings and time deposits (in amounts under $100,000), and balances in general accounts.
M3 Money supply measure that is composed of M2 plus time deposits over $100,000, term Eurodollar deposits, and all balances in institutional money market mutual funds.
Margin The amount of money or collateral deposited by a customer with a broker, by a broker with a clearing member, or by a clearing member with the clearinghouse in order to insure the broker or clearinghouse against loss on outstanding futures positions.
Mark-to-market Daily cash flow system used by the U.S. futures exchanges to maintain a minimum level of margin equity for a specific currency future or option by calculating the profit and loss at the end of each trading day in each contract position resulting from the price fluctuation.
Matched sale-purchase agreements Daily operations executed by the Federal Reserve, in which the Fed sells a security for immediate delivery to a dealer or a foreign central bank, with the agreement to buy back the same security at the same price at a predetermined time in the future (generally within seven days). This arrangement amounts to a temporary drain of reserves.
Matching systems Electronic systems duplicating the traditional brokers' market. A price shown by a bank is available to all traders.
Maturity date The date when a foreign exchange contract expires.
Merchandise Trade Balance An economic indicator that consists of the net difference between the exports and imports of a certain economy. The data includes food, raw materials and industrial supplies, consumer goods, autos, capital goods, and other merchandise.
Momentum An oscillator designed to measure the rate of price change, not the actual price level. This oscillator consists of the net difference between the current closing price and the oldest closing price from a predetermined period. The momentum is measured on an open scale around the zero line.
Moving average An average of a predetermined number of prices over a number of days, divided by the number of entries.
Moving average convergence-divergence (MACD) An oscillator that consists of two exponential moving averages (other inputs may be chosen by the trader as well) plotted against the zero line. The zero line represents the times the values of the two moving averages are identical. A buying signal is generated when this intersection is upward, whereas a selling signal occurs when the intersection takes place on the downside.
Moving averages ocillator An oscillator in which the values of two consecutive moving averages are subtracted from each other (the larger number of days from the previous one) and the new values are plotted.

Naked intervention (unsterilized intervention) A central bank intervention in the foreign exchange market that consists solely of the foreign exchange activity. This type of intervention has a monetary effect on the money supply and a long-term effect on foreign exchange.
National Association of Purchasing Managers Index (NAPM) A survey of 250 industrial purchasing managers, conducted in order to gauge the changes in new orders, production, employment, inventories, and vendor delivery speed.
National Futures Association (NFA) A self-regulatory organization that consists of futures commission merchants (FCMs), commodity pool operators (CPOs), commodity trading advisers (CTAs), introducing brokers (IBs), leverage transaction merchants (LTMs), commodity exchanges, commercial firms, and banks. It is responsible for certain aspects of the regulation of FCMs, CPOs, CTAs, IBs, and LTMs, focusing primarily on qualifications and proficiency, financial conditions, retail sales practices, and business.
Netting A process that enables institutions to settle only their net positions with one another at the end of the day, in a single transaction, not trade by trade.
Neural networks Computer systems that recognize patterns. They may be used to generate trading signals or to be part of trading systems.
Neutral spread (delta-neutral spread) A compound option strategy that consists of a long option position and a short option position whose respective total delta positions are relatively equal.
Next best price stop-loss order A stop-loss order that must be executed after the requested level is reached.
Nonfarm sector Jobs in government, manufacturing, services, construction, mining, retail and others.
Nostro account (clearing account) The account for each foreign currency in the country of origin maintained by the financial institutions for purchase and receiving (P&R) purposes.

Glossary And Foreign Exchange Terms (D-G)

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Daylight position limit The maximum amount of a certain currency a trader is allowed to carry at any single time, between the regular trading hours.
Dead cross An intersection of two consecutive moving averages that move in opposite directions and should technically be disregarded.
Dealing systems On-line computers that link the contributing banks around the world on a one-on-one basis.
Delta (A) (1) The change of the currency option price relative to a change in the currency price; (2) the hedge ratio between the option contracts and the currency futures contracts necessary to establish a neutral hedge; (3) the theoretical or equivalent share position. In the third case, delta is the number of currency futures contracts a call buyer is long or a put buyer is short. Delta ranges between 0 and 1.
Descending triangle A triangle continuation formation with a flat lower trendline and a downward-sloping upper trendline.
Descending triple bottom Bearish point-and-figure chart formation that suggests that the currency is likely to break a support line the third time it reaches it. Each new bottom is lower than the previous one.
Diagonal spread A compound option strategy that consists of several same-type options, in which the long side and the short side have different strike prices and different expirations.
Diamond A minor reversal pattern that resembles a diamond shape.
Direct dealing An aggressive approach in which banks contact each other outside the brokers' market.
Directional Movement Index A signal of trend presence in the market. The line simply rates the price directional movement on a scale of to 100. The higher the number, the better the trend potential of a movement, and vice versa.
Discount forward spread A forward price that is deducted from a spot price to calculate a forward price. It reflects the fact that the foreign interest rate is lower than the U.S. interest rate for that particular period.
Discount rate The interest rate at which eligible depository institutions may borrow funds directly from the Federal Reserve Banks. The rate is controlled by the Federal Reserve and is not subject to trading.
Discretion for range to trader stop-loss order A stop-loss order that gives the trader a number of discretionary pips within which the order has to be filled.
Double bottoms A bullish reversal pattern that consists of two bottoms of approximately equal heights. A parallel (resistance) line is drawn against a line that connects the two bottoms. The break of the resistance line generates a move equal in size to the price difference between the average height of the bottoms and the resistance line.
Double tops A bearish reversal pattern that consists of two tops of approximately equal heights. A parallel (support) line is drawn against a resistance line that connects the two tops. The break of the support line generates a move equal in size to the price difference between the average height of the tops and the support line.
Downside tasuki gap A bearish two-day candlestick combination. It consists of a second-day blank bar that closes an overnight gap opened on the previous day by a black bar.
Downward breakout of a bearish support line A bearish point-andfigure chart formation that confirms the currency's breakout of a support line the third time it reaches it.
Downward breakout of a bullish support line A bearish point-andfigure chart formation that confirms the currency's breakout of a support line the third time it reaches it. The support line is sloped upward.
Downward breakout from a consolidation formation A bearish pointand-figure chart formation that resembles the inverse flag formation. A valid downside breakout from the consolidation formation has a price target equal in size to the length of the previous downtrend.
Durable Goods Orders An economic indicator that measures the changes in sales of products with a life span in excess of three years.

Economic exposure Reflects the impact of foreign exchange changes on the future competitive position of a company.
Elliott Wave Principle A system of empirically derived rules for interpreting action in the markets. It refers to a five-wave/threewave pattern that forms one complete bull market/bear market cycle of eight waves.
Envelope model A band created by two winding parallel lines above and below a short-term moving average that borders most price fluctuations. When the upper band is penetrated, a selling signal occurs; when the lower band is penetrated, a buying signal is generated. Because the signals generated by the envelope model are very short-term and occur many times against the ongoing direction of the market, speed of execution is paramount.
Eurocurrency Currency deposit outside the country of origin.
Eurodollars U.S. dollar deposits placed in commercial banks outside the United States.
European Coal and Steel Community European entity established in 1951 by the Treaty of Paris, with the purpose of promoting inter-European trade in general, and eliminating restrictions on the trade of coal and raw steel in particular. West Germany, France, Italy, the Netherlands, Belgium, Luxembourg, and Great Britain formed this community.
European Commission The executive body of the European Economic Community in charge of making and observing the enforcement of policy. It consists of 23 departments, such as foreign affairs, competition policy and agriculture. Each country selects its own representatives for four-year terms, but the commissioners may only act for the benefit of the community. The commission is based in Brussels and consists of 17 members.
European Court of Justice The European Economic Community body in charge of settling disputes between the EC and member nations. It consists of 13 members and is based in Luxembourg.
European currency unit A basket of the member currencies. As a composite unit, the ECU consists of all the European Community currencies, which are individually weighted. It was created by the European Monetary System with the eventual goal of replacing the individual European member currencies.
European Economic Community A community established by the Treaty of Rome in 1951, with the goal of eliminating customs duties and any barriers against the transit of capital, services, and people among the member nations. The signatories were West Germany, France, Italy, the Netherlands, Belgium, and Luxembourg.
European Joint Float Agreement European monetary system established in April 1972 by the EC members: West Germany, France, Italy, the Netherlands, Belgium, and Luxembourg. Great Britain, Ireland, and Denmark were admitted by January 1973. The agreement allowed the member currencies to move within a 2.25 percent fluctuation band (nicknamed the snake). As a joint group, the agreement allowed these currencies to gyrate within a 4.5 percent band (nicknamed the tunnel). The entire agreement was known as the snake in the tunnel.
European Monetary Cooperation Fund EMS fund established to manage the EMS credit arrangements.
European Monetary Institute (EMI) The new European Central Bank created to govern the EMS. As of March 1994, it did not have any power over inter-EMS monetary policy.
European Monetary System European monetary system established in March 1979 by seven full members: West Germany, France, the Netherlands, Belgium, Luxembourg, Denmark, and Ireland. Great Britain did not participate in all of the arrangements and Italy joined under special conditions. New members: Greece in 1981, Spain and Portugal in 1986. Great Britain joined the Exchange Rate Mechanism in 1990. Also in 1990, West Germany became Germany as a result of its political unification with East Germany.
European Parliament The European Economic Community body in charge of reviewing and amending legislative proposals. It has the power to reject the budget proposals. It consists of 518 members who are elected. It is based in Luxembourg, but the sessions take place in Strasbourg or Brussels.
European Payment Union European entity instituted in 1950 to facilitate the inter-European settlements of international trade transactions.
European-style currency option An option that may only be exercised on the expiration date.
European Union Treaty Treaty signed by the 12 EMS members in February 1992 in the Dutch city of Maastricht, with the stated goal of forming a "closer union among the peoples of Europe."
Exchange for physical (EFP) Consists of deals executed in the cash market, outside the exchanges, for amounts equivalent to the currency futures amount, on forward outright prices valued for the futures' expiration. EFPs are generally quoted by commercial and investment banks, even during regular trading hours.
Exchange rate risk (1) Foreign exchange risk that is the effect of the continuous shift in the worldwide market supply and demand balance on an outstanding foreign exchange position. (2) Trading risk pertinent to market fluctuation.
Exercise (strike) price The price at which the underlying currency will be delivered upon exercise.
Exhaustion gap Price gap that occurs at the top or the bottom of a Vreversal formation. The trend changes direction in a rather uncharacteristically quick manner.
Expanding (broadening) triangle A triangle continuation formation that looks like a horizontal mirror image of a triangle; the tip of the triangle is next to the original trend, rather than its base.
Expiration date The delivery date.
Exponentially smoothed moving average A moving average that also takes into account the previous price information of the underlying currency.

Factory Orders An economic indicator that refers to total orders for durable and nondurable goods. The nondurable goods orders consist of food, clothing, light industrial products, and products designed for the maintenance of the durable goods.
FASB # 8 (Financial Accounting Standards Board's Statement Number 8) The original accounting rules regarding foreign exchange were standardized in 1975, which set the procedures for foreign currency translations into U.S. dollars in the consolidated balance sheets of U.S. multinational corporations.
FASB # 52 (Financial Accounting Standards Board's Statement Number 52) A complex set of rules designed in 1981, whose main objective is to move the foreign exchange P&L from current income into shareholders' equity.
Federal funds (Fed funds) Immediately available reserve balances at the federal reserves. The Fed funds are widely used by commercial banks or large corporations to lend to each other on an overnight basis. Although their level is established by the Fed, the prices fluctuate because they are traded in the market.
Federal Open Market Committee (FOMC) A committee established in 1935, through the Banking Act, to replace the Open Market Policy Conference (OMPC.) Currently active.
Federal Reserve The central bank of the United States. It was established in 1913 when Congress passed the Federal Reserve Act. The Act held that role of the Federal Reserve was "to furnish an elastic currency, to afford the means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes."
Federal Reserve Board The board consists of a Governor and four other regular members. The Secretary of the Treasury and the Comptroller of the Currency are closely consulted. The 12 regional Federal Reserve Banks around the country have sufficient autonomy to manage financial conditions in their districts. They are also managed by governors.
Fedwire An automated communications and settlement system linking the Federal Reserve banks with other banks and with depository institutions.
Fence A compound option strategy that consists of either a long currency position—a long out-of-money put and a short out-of-themoney call, where the options have the same expiration date (risk conversion); or a short currency position—a short out-of-the-money put and a long out-of-the-money call, where the options have the same expiration date (risk reversal).
Fibonacci percentage retracements Price retracements of 0.382 and 0.618, or approximately 38 percent and 62 percent. Fibonacci ratio 0.618 and 0.312.
Fibonacci sequence Takes a sequence of numbers that begins with 1 and adds 1 to it, then takes the sum of this operation (2) and adds it to the previous term in the sequence (1). Next it takes the sum of the second operation (3) and adds it to the previous term in the sequence (the sum of the first operation, i.e., 2). The Fibonacci sequence continues iterating in this manner, adding the most recent sum to the previous term, which is itself the sum of the two previous terms, etc. This yields the following series of numbers: 1 1 2 3 5 8 13 21 34 55 89 144 233 377 610 987 1597 2584 4181 (etc.).
FINEX A currency market that is part of the New York Cotton Exchange (NYCE), the oldest futures exchange in New York. The exchange lists futures on the European Currency Unit and the USDX, a basket of ten currencies: deutsche mark, Japanese yen, French franc, British pound, Canadian dollar, Italian lira, Dutch guilder, Belgian franc, Swedish krona, and Swiss franc.
Fisher effect A theory holding that die nominal interest rate consists of the real interest rate plus the expected rate of inflation.
Flag A continuation formation that resembles the outline of a flag. It consists of a brief consolidation period within a solid and steep upward trend or downward trend. The consolidation itself tends to be sloped in the opposite direction from the slope of the original trend, or simply flat. The consolidation is bordered by a support line and a resistance line, which are parallel to each other or very mildly converging, making it look like a flag (parallelogram). The previous sharp trend is known as the flagpole. When the currency resumes its original trend by breaking out of the consolidation, the price objective is the total length of the flagpole, measured from the breakout price level.
Floor brokers Any individuals on the exchange floor engaged in executing orders for another person. They may also trade for their own accounts, with the primary responsibility of executing the customers' orders first. Brokers are licensed by the federal government.
Floor traders (locals) Exchange members who execute their own trades by being physically present in the pit, or place for futures trading.
Foreign exchange The mechanism that values foreign currencies in terms of another currency.
Foreign exchange brokers Intermediaries among banks who bring together buyers and sellers to the market, optimize the prices they show to their customers, and do not take positions for themselves.
Foreign exchange exposure The potential effect of currency fluctuations on shareholders' equity.
Foreign exchange rate The price of one currency in terms of another.
Forward outright Foreign exchange deal that matures at a day past the spot delivery date (generally two business days).
Forward spread (forward points or forward pips) Forward price used to adjust a spot price to calculate a forward price. It is based on the current spot exchange rate, the interest rate differential, and the number of days to delivery.
Fractal geometry Geometry theory that refers to the fact that certain irregular objects have a fractal number of dimensions. In other words, an object cannot fill an integer number of dimensions.
French-West German Treaty of Cooperation A treaty signed in 1963 by President Charles de Gaulle and Chancellor Konrad Adenauer, which established that West Germany would lead economically through the cold war and France, the former diplomatic powerhouse, would provide the political leadership.
Fuzzy logic Method that attempts to weigh the quality of the patterns recognized by neural networks. Because not all patterns have equal financial significance for foreign currency forecasting, this method qualifies the degree of certainty of the results.

Gamma The rate of change of an option's delta, or the sensitivity of the delta.
Gann percentage retracements The Gann theory focuses mostly on the eighths, along with retracements in thirds.
Gap The price gap between consecutive trading ranges (i.e., the low of the current range is higher than the high of the previous range).
Genetic algorithms Method used to optimize a neural network. Trial and error are applied to an evolutionlike system, which mimics natural selection for financial forecasting purposes.
GLOBEX An electronic trading system conceived in 1987 as an afterhours trading system and geared toward global futures trading; created through a joint venture of the Chicago Mercantile Exchange (CME), the Chicago Board of Trade (CBT), and Reuters PLC.
Golden cross An intersection of two consecutive moving averages that move in the same direction and suggest that the currency will move in the same direction.
Gross Domestic Product The sum of all goods and services produced in the United States.
Gross National Product The sum of government expenditure, private investment, and personal consumption.
Gross National Product Implicit Deflator Deflator tool designed to adjust the Gross National Product for inflation. It is calculated by dividing the current dollar GNP figure by the constant dollar GNP figure.

Glossary And Foreign Exchange Terms (A-C)

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Accumulation swing index (ASI) An oscillator based on the swing index (SI.) A buying signal is generated when the daily high exceeds the previous SI significant high, and a selling signal occurs when the daily low dips under the significant SI low.
American style currency option An option that may be exercised at any valid business date throughout the life of the option.
Arbitrage A risk-free type of trading in which the same instrument is bought and sold simultaneously in two different markets in order to cash in on the divergence between the two markets.
Ascending triangle A triangle continuation formation with a flat upper trendline and a bottom sloping upward trendline. (See Triangle.)
Ascending triple top A bullish point-and-figure chart formation that suggests that the currency is likely to break a resistance line the third time it reaches it. Each new top is higher than the previous one.
Atekubi A bearish two-day candlestick combination. It consists of a blank bar that closes at the daily high; the current closing price equals the previous day's low. The original day's range is a long black bar.
At par forward spread Forward price is zero; therefore, the spot price is similar to the forward price. It reflects the fact that the foreign interest rate is similar to the U.S. interest rate for that particular period.
At-the-money (ATM) option An option whose present currency price is approximately equal to the strike price.
At the price stop-loss order A stop-loss order that must be executed at the precise requested level, regardless of market conditions.
Average options Options that refer to the average rate of the underlying currency that existed during the life of the option. This rate becomes the strike in the case of the average strike options; or it becomes the underlying, determining the intrinsic value when compared to a predetermined fixed strike in the case of average rate options.
Average options can be based on the spot rate (spot style) or on the forward underlying the option (forward style.) The average can be calculated arithmetically or geometrically, and the rates can be tabulated with a variety of frequencies.

Balance-of-payments All the international commercial and financial transactions of the residents of one country.
Bank of Canada (BOC) The central bank of Canada.
Bank of England (BOE) The central bank of the United Kingdom. It is a less independent central bank. The government may overwrite its decision.
Bank of France (BOF) The central bank of France.
Bank of Italy (BOI) The central bank of Italy.
Bank of Japan (BOJ) The Japanese central bank. Although its Policy Board is still fully in charge of the monetary policy, changes are still subject to the approval of the Ministry of Finance (MOF). The BOJ targets the M2 aggregate.
Bar chart A type of chart that consists of four significant points: the high and the low prices, which form the vertical bar; the opening price, which is marked with a little horizontal line to the left of the bar; and the closing price, which is marked with a little horizontal line to the right of the bar.
Barrier options (trigger options, cutoff options, cutout options, stop options, down/up-and-outs/ins, knockups) Options very similar to European style vanilla options, except that a second strike price (the trigger) is specified that, when reached in the market, automatically causes the option to be expired (knockout options) or "inspired" (knockin options).
Bearish tasuki A bearish two-day candlestick combination. It consists of a long blank bar that has a low above 50 percent of the previous day's long black body, and closes marginally above the previous day's high. The second day's rally is temporary, as it is caused only by profit-taking. The sell-off is likely to continue the next day.
Bearish tsutsumi (the engulfing pattern) A bearish two-day candlestick combination. It consists of a second-day bearish candlestick whose body "engulfs" the previous day's small bullish body.
Bilateral grid An exchange rate system that links all the central rates of the EMS currencies in terms of the ECU.
Black closing bozu A bearish candlestick formation that consists of a long black bar (upper shadow).
Black marubozu (shaven head) A bearish candlestick formation that consists of a long black bar (no shadow).
Black opening bozu A bearish candlestick formation that consists of a long black bar (lower shadow).
Black-Scholes fair value model The original option pricing model, which holds that a stock and the call option on the stock are comparable investments and thus a risk less portfolio may be created by buying the stock and selling the option on the stock, as a hedge. The movement of the price of the stock is reflected by the movement of the price of the option, but not necessarily by the same amplitude. Therefore, it is necessary to hold only the amount of the stock necessary to duplicate the movement of the price of the option.
Blank closing bozu A bullish candlestick formation that consists of a long blank bar (lower shadow).
Blank marubozu (shaven head) A bullish candlestick formation that consists of a long blank bar (no shadows).
Blank opening bozu A bullish candlestick formation that consists of a long blank bar (upper shadow).
Bollinger bands A quantitative method that combines a moving average with the instrument's volatility. The bands were designed to gauge whether the prices are high or low on a relative basis. They are plotted two standard deviations above and below a simple moving average. The bands look like an expanding and contracting envelope model. When the band contracts drastically, the signal is that volatility will expand sharply in the near future. An additional signal is a succession of two top formations, one outside the band followed by one inside. If it occurs above the band, it is a selling signal. When it occurs below the band, it is a buying signal.
Box spread A compound option strategy that consists of four options with a common expiration date: a long call and a short put at one strike price, and a long put and a short call at a different strike price.
Breakaway gap A price gap that occurs in the beginning of a new trend, many times at the end of a long consolidation period. It may also appear after the completion of major chart formations.
Breakout of a spread triple bottom A bearish point-and-figure chart formation that suggests that the currency is likely to break a support line the third time it reaches it. The currency failed to reach the support line once.
Breakout of a spread triple top A bullish point-and-figure chart formation that suggests that the currency is likely to break a resistance line the third time it reaches it. The currency failed toreach the resistance line once.
Breakout of a triple bottom A bearish point-and-figure chart formation that suggests that the currency is likely to break a support line the third time it reaches it.
Breakout of a triple top A bullish point-and-figure chart formation that suggests that the currency is likely to break a resistance line the third time it reaches it.
Bullish tasuki A bullish two-day candlestick combination. It consists of a long black bar that has a high above 50 percent of the previous day's long blank body, and closes marginally below the previous day's low.
Bullish tsutsumi (the engulfing bar) A bullish two-day candlestick combination. It consists of a second bullish candlestick whose body "engulfs" the previous day's small bearish body.
Bundesbank The German central bank. In addition to its domestic obligations, the Bundesbank has had international obligations since 1979 as the front player of the European Monetary System. The Bundesbank is a very independent central bank.
Business firms (establishment) survey Survey of the payroll, workweek, hourly earnings, and total hours of employment in the non farm sector.
Business Inventories An economic indicator that consists of the items produced and held for future sale.
Butterfly spread A compound option strategy that consists of a combination of a bull spread and a bear spread, using either calls or puts.

Calendar combination A compound option strategy that consists of the simultaneous call calendar spread and put calendar spread, in which the strike price of the calls is higher than the strike price of the puts.
Calendar spread A combination option of two similar types of options, either calls or puts, with the same strike price but different expiration dates. The dissimilarity between the expiration dates allows this type of spread to capitalize on both the impact of the time decay and the interest rate differentials.
Calendar straddle A compound option strategy that consists of simultaneous buying of a longer-term straddle and a near-term straddle with a common strike price.
Call ratio backspread A compound option strategy that consists of short calls with a lower strike price and more long calls with a higher strike price. The profit is twofold. The maximum upside profit potential is unlimited. The downside profit potential consists of the total premium received. The maximum loss potential occurs when the currency price reaches the higher strike price at expiration.
Candlestick chart A type of chart that consists of four major prices: high, low, open, and close. The body (jittai) of the candlestick bar is formed by the opening and closing prices. To indicate that the opening was lower than the closing, the body of the bar is left blank. If the currency closes below its opening, the body is filled. The rest of the range is marked by two "shadows": the upper shadow (uwakage) and the lower shadow (shitakage).
Capacity utilization An economic indicator that consists of total industrial output divided by total production capability. The term refers to the maximum level of output a plant can generate under normal business conditions.
Cardinal square A Gann technique for forecasting future significant chart points by counting from the all-time low price of the currency. It consists of a square divided by a cross into four quadrants. The all-time low price is housed in the center of the cross. All of the following higher prices are entered in clockwise order. The numbers positioned in the cardinal cross are the most significant chart points.
Channel line A parallel line that can be traced against the trendline, connecting the significant peaks in an uptrend, and the significant troughs in a downtrend.
Chaos theory A theory that holds that statistically noisy behavior may occur randomly, even in simple environments. This seemingly random behavior may be predicted with decreasing accuracy if the source is known.
CHIPS (Clearing House Interbank Payments System) A computerized system used for foreign exchange dollar settlements.
Christmas tree spread A compound option strategy that consists of several short options at two or more strike prices.
Classes of options The types of options: calls and puts.
Combination spread (synthetic future) A compound option strategy that consists of a long call and a short put, or a long put and a short call, with a common expiration date.
Commodity Channel Index (CCI) An oscillator that consists of the difference between the mean price of the currency and the average of the mean price over a predetermined period of time. A buying signal is generated when the price exceeds the upper (+100) line, and a selling signal occurs when the price dips under the lower (-100) line.
Commodity Futures Trading Commission (CFTC) An independent agency created by Congress in 1974 with a mandate to regulate commodity futures and options markets in the United States. The CFTC's responsibilities are to ensure the economic utility of futures markets, via competitiveness and efficiency; ensure the integrity of these markets; and protect the participants against manipulation, fraud, and abusive practices. The Commission, based in Washington, D.C., regulates the activities of 285 commodity brokerage firms; 48,211 salespeople; 8017 floor brokers; 1325 commodity pool operators (CPOs); 2733 commodity trading advisers (CTAs); and 1486 introducing brokers (IBs).
Commodity Research Bureau's (CRB) Futures Index Index formed from the equally weighted futures prices of 21 commodities. The preponderance of food commodities makes the CRB Index less reliable in terms of general inflation.
Common gap A price gap that occurs in relatively quiet periods or in illiquid markets. It has limited technical significance.
Condor spread A compound option strategy that consists of either four same-type options with a common expiration date—two long options with consecutive strike prices, one short option with an immediately lower strike price, and one short option with an immediately higher strike price; or four same-type options with a common expiration date—two short options with consecutive strike prices, one long option with an immediately lower strike price, and one long option with an immediately higher strike price.
Consumer Price Index (CPI) An economic indicator that gauges the average change in retail prices for a fixed market basket of goods and services.
Consumer sentiment A survey of households designed to gauge the individual propensity for spending. There are two studies conducted in this area, one survey by the University of Michigan, and the other by the National Family Opinion for the Conference Board. The confidence index measured by the Conference Board is sensitive to the job market, whereas the index generated by the University of Michigan is not.
Continuation patterns Technical signals that reinforce the current trends.
Cost of carry The interest rate parity, whereby the forward price is determined by the cost of borrowing money in order to hold the position.
Council of Ministers The legislative body of the European Economic Community in charge of making the major policy decisions. It is composed of ministers from all the 12 member nations. The presidency rotates every six months by all the 12 members, in alphabetical order. The meetings take place in Brussels or in the capital of the nation holding the presidency.
Country (sovereign) risk A trading risk emerging from a government's interference in the foreign exchange markets.
Covered interest rate arbitrage An arbitrage approach that consists of borrowing currency A, exchanging it for currency B, investing currency B for the duration of the loan, and, after taking off the forward cover on maturity, showing a profit on the entire set of deals.
Covered long A compound option strategy that consists of selling a call against a long currency position. A covered long is synonymous with a short put.
Covered short A compound option strategy that consists of shorting a put against a short currency position. A covered short is synonymous with a short call.
Cox, Ross, and Rubinstein pricing model An option pricing model that takes into consideration the early exercise provision of the American style options. As it assumes that early exercise will occur only if the advantage of holding the currency exceeds the time value of the option, their binomial method evaluated the call premium by estimating the probability of early exercise for each successive day. The theoretical premium is compared to the holding cost of the cash hedge position, until the option's time value is worth less than the forward points of the currency hedge and the option should be exercised.
Credit risk The possibility that an outstanding currency position may not be repaid as agreed, due to a voluntary or involuntary action by a counterparty.
Cross rates Currencies traded against currencies other than the U.S. dollar. A cross rate is a non-dollar currency.
Currency call A contract between the buyer and seller that holds that the buyer has the right, but not the obligation, to buy a specific quantity of a currency at a predetermined price and within a predetermined period of time, regardless of the market price of the currency. The writer assumes the obligation of delivering the specific quantity of a currency at a predetermined price and within a predetermined period of time, regardless of the market price of the currency, if the buyer wants to exercise the call option.
Currency fixings An open auction executed in Europe on a daily basis in which all players, regardless of size, are welcome to participate with any amount.
Currency futures A specific type of forward outright deal with standardized expiration date and size of the amount.
Currency option A contract between a buyer and a seller, also known as writer, that gives the buyer the right, but not the obligation, to trade a specific quantity of a currency at a predetermined price and within a predetermined period of time, regardless of the market price of the currency; and gives the seller the obligation to deliver or buy the currency under the predetermined terms, if and when the buyer wants to exercise the option.
Currency put A contract between the buyer and the seller that holds that the buyer has the right, but not the obligation, to sell a specific quantity of a currency at a predetermined price and within a predetermined period of time, regardless of the market price of the currency. The writer assumes the obligation to buy the specific quantity of a currency at a predetermined price and within a predetermined period of time, regardless of the market price of the currency, if the buyer wants to exercise the call option.
Current account balance The broadest current dollar measure of U.S. trade, which incorporates services and unilateral transfers into the merchandise trade data.

Reversal Candlestick Formations

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Neutral Candlestick Formations

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Bearish Candlestick Formations

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Bullish Candlestick Formations

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Basic Candlestick Patterns

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Spinning Tops

Candlesticks with a long upper shadow, long lower shadow and small real bodies are called spinning tops. The color of the real body is not very important.
The pattern indicates the indecision between the buyers and sellers The small real body (whether hollow or filled) shows little movement from open to close, and the shadows indicate that both buyers and sellers were fighting but nobody could gain the upper hand. Even though the session opened and closed with little change, prices moved significantly higher and lower in the meantime. Neither buyers nor sellers could gain the upper hand, and the result was a standoff. If a spinning top forms during an uptrend, this usually means there aren’t many buyers left and a possible reversal in direction could occur. If a spinning top forms during a downtrend, this usually means there aren’t many sellers left and a possible reversal in direction could occur.

Marubozu

Sounds like some kind of voodoo magic huh? "I will cast the evil spell of the Marubozu on you!" Fortunately, that's not what it means. Marubozu means there are no shadows from the bodies. Depending on whether the candlestick’s body is filled or hollow, the high and low are the same as it’s open or close. If you look at the picture below, there are two types of Marubozus.

A White Marubozu contains a long white body with no shadows. The open price equals the low price and the close price equals the high price. This is a very bullish candle as it shows that buyers were in control the whole entire session. It usually becomes the first part of a bullish continuation or a bullish reversal pattern. A Black Marubozu contains a long black body with no shadows. The open equals the high and the close equals the low. This is a very bearish candle as it shows that sellers controlled the price action the whole entire session. It usually implies bearish continuation or bearish reversal.

Doji
Doji candlesticks have the same open and close price or at least their bodies are extremely
short. The doji should have a very small body that appears as a thin line. Doji suggest indecision or a struggle for turf positioning between buyers and sellers. Prices move above and below the open price during the session, but close at or very near the open price.

Neither buyers nor sellers were able to gain control and the result was essentially a draw. There are four special types of Doji lines. The length of the upper and lower shadows can vary and the resulting candlestick looks like a cross, inverted cross or plus sign. The word "Doji" refers to both the singular and plural form. When a doji forms on your chart, pay special attention to the preceding candlesticks. If a doji forms after a series of candlesticks with long filled bodies (like white marubozus), the doji signals that the buyers are becoming exhausted and weakening. In order for price to continue rising, more buyers are needed but there aren’t anymore! Sellers are licking their chops and are looking to come in and drive the price back down.

Sexy Bodies and Strange Shadows

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Just like humans, candlesticks have different body sizes. And when it comes to forex trading, there’s nothing naughtier than checking out the bodies of candlesticks! Long bodies indicate strong buying or selling. The longer the body is, the more intense the buying or selling pressure. Short bodies imply very little buying or selling activity. In street forex lingo, bulls mean

buyers and bears mean sellers.

Long white candlesticks show strong buying pressure. The longer the white candlestick, the further the close is above the open. This indicates that prices increased considerably from open to close and buyers were aggressive. In other words, the bulls are kicking the bears’ butts big time! Long black (filled) candlesticks show strong selling pressure. The longer the black candlestick, the further the close is below the open. This indicates that prices fell a great deal from the open and sellers were aggressive. In other words, the bears were grabbing the bulls by their horns and body slamming them.

Mysterious Shadows
The upper and lower shadows on candlesticks provide important clues about the trading session. Upper shadows signify the session high. Lower shadows signify the session low. Candlesticks with long shadows show that trading action occurred well past the open and close.

Candlesticks with short shadows indicate that most of the trading action was confined near the open and close. If a candlestick has a long upper shadow and short lower shadow, this means that buyers flexed their muscles and bided prices higher, but for one reason or another, sellers came in and drove prices back down to end the session back near its open price. If a candlestick has a long lower shadow and short upper shadow, this means that sellers flashed their washboard abs and forced price lower, but for one reason or another, buyers came in and drove prices back up to end the session back near its open price.

Candlestick charts I

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Candlestick charts show the same information as a bar chart, but in a prettier, graphic format. Candlestick bars still indicate the high-to-low range with a vertical line. However, in candlestick charting, the larger block in the middle indicates the range between the opening and closing prices. Traditionally, if the block in the middle is filled or colored in, then the currency closed lower than it opened. In the following example, the ‘filled color’ is black. For our ‘filled’ blocks, the top of the block is the opening price, and the bottom of the block is the closing price. If the closing price is higher than the opening price, then the block in the middle will be “white” or hollow or unfilled.

We don’t like to use the traditional black and white candlesticks. We feel it’s easier to look at a chart that’s colored. A color television is much better than a black and white television, so why not in candlestick charts? We simply substituted green instead of white, and red instead of black. This means that if the price closed higher than it opened, the candlestick would be green. If the price closed lower than it opened, the candlestick would be red. In our later lessons, you will see how using green and red candles will allow you to “see” things on the charts much faster, such as uptrend/downtrends and possible reversal points. For now, just remember that we use red and green candlesticks instead of black and white and we will be using these colors from now on.

Developing a trading method

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After such a loss, traders blame themselves, repeatedly going through the details of the unsuccessful trade. They blame the market for the “wrong behavior” or themselves for errors in what then seems an absolutely clear situation. Sometimes, the trader-market relationship takes the form of a vendetta. Traders consider the market as their personal enemy, treat it in an unfriendly way (even with hate) and dream of immediate revenge. Doing so, they miss the fact that they are essentially blaming nature for changing sunny weather to rain. It is very important to be prepared beforehand for this change. Trades should always have close at hand one or a few options in case of sudden change of the situation/weather, so that their foresight assures their good time or good profit. The third main psychological problem is trader uncertainty, especially when traders are inexperienced in abilities and skills—specifically about each market position they hold. Immediately after each position is opened and a money contract is bought, traders start questioning their choices. This is revealed most vividly in the case of a moderately active market at the moment of fluctuations close to the opening price of the position. Any movement (even insignificant) against their position causes traders to have an irresistible desire to sell the recently acquired contract to limit losses, until it is too late and the market does not shift too far away from their position opening price. On the other hand, an insignificant market shift in the desirable direction causes the same desire to eliminate the position, until it provides for any (even tiny) profit and before this profit does not turn into losses. Scared and troubled traders rush and race about. They open and liquidate their positions too often, and experience many small losses and gains. Within a short period of time, they turn intermittently into bulls or bears. As a result, they suffer losses on a dealer’s spread and/or commissions when there were no significant market changes, and all the market fluctuations were no more than just regular market “noise.” Such losses are typical for beginners and individual traders with small investment capital or little experience and insufficient psychological preparation.

Not uncommon are cases of traders’ impulsive decisions on trading, without any plans or serious preliminary market analysis. The position is opened under an impulsive, invalid emotional reaction. Often, it can be explained by traders’ fears of losing a brilliant opportunity to earn money they think is being offered by the market at that moment. I have witnessed these attempts to jump onto the last carriage of a departing train, and such attempts have ruined a lot of traders. Many traders cannot calmly watch any kind of market movements. Some of my students have confirmed this reality. If they have no positions at the moment of more or less significant market movement, they consider it as a lost opportunity to gain profit. This can inflict a serious shock to them.

Psychological Challenges of Speculative
When they have no position, they seem unable to realize that each market movement can be considered both ways, and the opposite situation can quite possibly develop. Statistics show that, at each market movement, the chances to lose are much higher than to profit. How does it happen that reasonable people (who in everyday life, without any emotion, can watch a bank cashier counting other people’s money) consider the fact of market movement as a threat to their own pockets? Why is other people’s money in the hands of a bank cashier not considered as a lost profit, whereas capital shift on the market and the corresponding quote fluctuations are the causes of negative emotions? I think the answer is in the illusory simplicity of business itself, which is considered by many people as a good and simple opportunity to earn a lot of easy money. Similar notions are widely spread among novice currency traders. The soon traders abandon such ideas, the sooner they become professionally efficient traders. The most difficult problem for every trader (regardless of their experiences) is to learn as quickly as possible how to recover quickly from losses, which are inevitable in this business. At the same time, they must
learn to handle shocks and psychological damage inflicted by the losses, because these situations could negatively influence their future work.

The losses themselves and the fear of losing, both of which permanently torture traders, negatively influence their ability to make reasonable decisions in a complicated situation. These factors also undermine traders’ ability to follow their own rules about trade strategies and systems.

I have become personally acquainted with hundreds of traders and have watched their activities. I have taught many students, and have had my own experience as a trader at various steps of my career in the currency market. Therefore, I have come to the conclusion that the main causes of trader failures in speculative operations in the FOREX market are without a doubt those associated with psychological trauma—the inability to control their own emotions and to find an adequate way to fight stress. I have explored ways of solving the psychological problems that arise from operations in the FOREX market, with the focus on increasing selfresistance to stressful situations and increasing trade effectiveness. As a result of my research, I have managed to develop a trading method that also helps to withstand shocks and keep emotions under control. To solve the problem of stress, I had to separate the problem into several parts and solve them one by one.

First, it was necessary to develop the philosophical conception of my attitude toward market situations. By this I mean not only the general trade methods, which are discussed in the second part of the course, but also my own conception of the market and associated psychological problems, which most traders (including myself) have to overcome daily. The following formula is essential for my conception: I can’t be wrong if I don’t have an opinion. I had this in mind as I thought about how to avoid unwanted stress and emotions that are associated with trading. When you find a way to make reasonable decisions not based on your own opinion about future market trends but in accordance with certain market signals, the problem of diminishing and almost completely eliminating psychological pressure and stress will be solved. The key issue in this case is a philosophical attitude about market trends—they are natural phenomena beyond human control and forecast. The trick was to develop a secure and effective trade strategy that could advantageously use these natural phenomena. This formula seemed logical and could provide the basis for the development of a conceptual trading strategy. In reality, however, this job took considerable time. Nevertheless, the formula was used as a base for the development of my system- trade methods that I called the method of discrete-systematic trading. Moving from the basic formula and general philosophical idea through intermediate conclusions, I came to the development of the trade method. This method provides for trading practically without emotions, and it became a very effective and profitable tool to earning money in currency speculations.

The logical chain of my arguments and intermediate conclusions is the following:

Idea 1. The main source of negative emotions and stresses is the unfulfilled trader’s forecast, based on the trader’s notion about market future trends.
Idea 2. To avoid unnecessary emotions and psychological pressure, it is better to completely abandon any notion about market future trends because this notion itself forms the forecast, which could be wrong.
Idea 3. The basic idea of the formula “I cannot be wrong if I don’t have an opinion” transfers the moral obligation for trading results from the trader to the market. Now, the fluctuation of the market can be considered as a manifestation of the so-called “God’s Will” or “Force of Nature,” so the trader cannot be responsible for that.
Idea 4. It is possible to abandon attempts to make forecasts and still have a profit only if one stops trying to foresee market trends but follows them instead.
Idea 5. It is possible to follow market fluctuations using only the system- trade method and developing a trading strategy providing effective monitoring of these fluctuations.
Idea 6. One of the best methods of this approach could be the one providing the objective evaluation of the possibility of the market’s movements at any moment in both possible directions.

Psychological Trading

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A successful trader’s career mainly depends on his or her psychological stability in stressful situations, which are common in the process of trading. Theoretical knowledge can be acquired by reading professional literature; practical skills and experience are acquired in the process of actual trading. The most difficult process is adjusting psychological stress, because in real life it is impossible to completely eliminate the stress factor influencing human activity. Underestimating the stress factor could play a mean trick on traders and even completely block their abilities to make reasonable decisions in real trading situations.

The psychological stress of those trading in the FOREX (and any other) market is extremely high. Traders must work under permanent psychological pressure, making decisions in highly unpredictable and uncertain market situations. Each trader goes through mistakes, failures, and losses in his or her own way, in accordance with his or her personality and temper. Some might blame their failures on the market’s “wrong behavior,” which didn’t comply with the trader’s brilliant forecast and caused the failure of the magnificently planned speculative combination. Others blame themselves and their own inabilities to make right decisions in situations, which afterwards seem to be simple. It is an interesting fact that, in hindsight, traders usually find the decision that should have been made at the lost critical moment and can reasonably prove their point of view. Why can they find the right decision so easily and quickly in hindsight? Was the trader unable to do so at the right moment? I don’t think it can be simply explained by looking at yesterday’s situation from today’s point of view. I do not think it can be explained by the fact that classical technical analysis allows for multiple explanations of almost any market situation. It is always possible to find an appropriate basic explanation for any market shift after the event takes place. In the heat of the moment, however, the trader was influenced by stress, and that stress caused the error. This is proven by the fact that most novice traders show exceptionally good (and even phenomenal) results trading dummy accounts but can’t even come near those
results when trading with real money. Being permanently under stress, a trader can often make insufficiently considered, impulsive, and, therefore, wrong decisions that result in losses or premature liquidation of profitable positions, that is, in lost profit. Sometimes, after a few successive failures with various trades, traders becomes fearful of the market. They are in a state of psychological stupor, and even a simple market situation may cause panic. They cannot
overcome their emotions or soberly evaluate the current situation, and they are unable to make any decision—reasonable or otherwise. In many cases when the market situation shifts against the trader’s position, they can only passively watch the growth of their losses, because they are unable to make any decision at all. Often, after the market stabilizes and traders have the opportunity to calmly analyze daily diagrams of currency fluctuations, they come to the conclusion that the main cause of failure was not the lack of knowledge or training but their own emotions. However, the situation cannot be reversed. Time has passed, money has been lost, and everything should be begun again.

Another problem that causes severe and even catastrophic consequences is the trader’s wishful thinking. In this case, traders are sure that their forecast of market trends is solely correct. They feel the market cannot and should not give any surprises. They do not consider other options that could be helpful or they think of other options in a vague and uncertain form. Sometimes, traders consider a market shift against their position as short-term and temporary. They begin to average their positions. They acquire new contracts at a lower price in the hope that the market situation will come back, and all the positions will become highly profitable. Afterwards, as the situation worsens, they will be able to come out of the market without serious losses. Being sure they are right, traders lose the ability to critically evaluate the condition of the market and accordingly their own position in the market. In this case, they consider only those basic and technical features that justify their wishful thinking, and they discard the contradicting features. This wishful thinking costs them dearly and can lead to psychological frustration. The market’s “wrong behavior” not only deprives traders of a certain amount of money and often ruins their trading account, but also undermines their self-esteem and their hopes of being a winner in the trading battle.

Lines of trends, support and resistance

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The trendline is a main initial element for the price chart analysis. While the market moves in any direction not along a straight line but along a zigzag, the mutual placement of upper and bottom points of those zigzags permits you to plot a line connecting the significant highs (peaks) or the significant lows (troughs) of an appropriate zigzag using technical tools of the computer program. To draw a trendline only two points are necessary and the third one is the contact point confirmation. On a bullish trend chart it should be drawn using troughs, on a bearish trend chart – using peaks. The trendline and a line which is about parallel to it and drawn on the opposite side (through peaks on a dullish trend and through troughs on a bearish) form the trade channel. Both lines are then channel’s borders.

Lines of support and resistance. The upper and the bottom borders of trade channels are called accordingly support and resistance lines. The peaks represent the price levels at which the selling pressure exceeds the buying pressure. They are known as resistance levels. The troughs, on the other hand, represent the levels at which the selling pressure succumbs to the buying pressure. They are called support levels. In an uptrend, the consecutive support and resistance levels must exceed each other respectively. The reverse is true in a downtrend. Although minor exceptions are acceptable, these failures should be considered as warning signals for trend changing.

The significance of trends is a function of time and volume. The longer the prices bounce off the support and resistance levels, the more significant the trend becomes. Trading volume is also very important, especially at the critical support and resistance levels. When the currency bounces off these levels under heavy volume, the significance of the trend increases. The importance of support and resistance levels goes beyond their original functions. If these levels are convincingly penetrated, they tend to turn into just the opposite. A firm support level, once it is penetrated on heavy volume, will likely turn into a strong resistance level. Conversely, a strong resistance turns into a firm support after being penetrated. In general, to evaluate the reliability (that is the possibility of a break) of the trade channel borders taking a decision to close or to save an existing position one should govern himself with following rules:

A channel is the more reliable the longer it exists. Hence, the “solidity” of very old channels (e.g. existing more than 1 year) decreased sharply.
A channel is the more reliable the more is his width (“It takes time to break channel”).
The resistance may be broken if it is bounced on the background of a growing volume (“It takes volume to break resistance”).
A steep channel is less reliable in compare to a gentle one.
The support may be broken independent on the volume (“under own weight”).

Candlestick chart

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The candlestick chart is closely related to the bar chart. It also consists of four major prices: high, low, open, and close. In addition to the common readings, the candlestick chart has a set of particular interpretations. The latter is possible thanks to the convenient visual observation of that chart.

The opening and closing prices form the body (jittai) of the candlestick. To indicate that the opening was lower than the closing, the body of the bar is left blank. Current standard electronic displays allow you to keep it blank or select a color of your choice. If the currency closes below its opening, the body is filled. In its original form, the body was colored black, but the electronic displays allow you to keep it filled or to select a color of your choice. The intraday (or weekly) direction on a candlestick chart can be traced by means of two "shadows": the upper shadow (uwakage) and the lower shadow (shitakage). Just as with a bar chart, the candlestick chart is unable to trace every price movement during a period's activity.

Charts for the technical analysis

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Kinds of prices and time units. Charts for technical analysis are being constructed in coordinates, “price (the vertical axis) – time (the horizontal axis)”. The following kinds of currency prices represented on charts are being distinguished on Forex:

open – a price at the beginning of a trade period (year, month, day, week, hour, minute or a certain amount of one from these units);
close - a price at the end of a trade period;
high – the highest from prices observed during a trade period;
low – the lowest from prices observed during a trade period.

Providing the technical analysis one uses charts for different time units – from 1 year or more until 1 minute. For instance, the computer program Trading Intl. uses allows you to analyze price movement charts for 1 day, 4 hours, 30 minutes, 15 minutes, 5 minutes and 1 minute. The longer the time unit applied to plotting the chart, the longer the time span used to analyze price movements and to determine the major trend by means of the chart. For short trading, charts for smaller time units are more suitable.

Line chart. The line chart is plotted connecting single prices for a selected time period. The most popular line chart is the daily chart. Although any point in the day can be plotted, most traders focus on the closing price, which they perceive as the most important. But an immediate problem with the daily line chart is the fact that it is impossible to see the price activity for the balance of the period as well as gaps breakups in prices at joints of trade periods. Nevertheless, line charts are easier to visualize. Also, technical analysis goes well beyond chart formation; in order to execute certain models and techniques, line charts are better suited than any of the other charts.

Bar chart. The bar chart consists from separate histograms. To plot a histogram in coordinates price – time the points responding to high, low, open and close prices for a time period analyzed should be marked on the one vertical bar. The opening price usually is marked with a little horizontal line to the left of the bar; and the closing price is marked with a little horizontal line to the right of the bar. Bar charts have the obvious advantage of displaying the currency range for the period selected. An advantage of this chart is that, unlike line charts, the bar chart is able to plot price gaps. Hence, it is impossible to see on a bar chart absolutely all price movements during the period.

Technical analysis

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Technical analysis is used for the prediction of market movements (that is alterations in currencies prices, volumes and open interests) outgoing from the information obtained for the past. The main instruments of technical analysis are different kinds of charts, which represent currencies price change during a certain time preceding exchange deals, as well as technical indicators. The latter are obtained as a result of the mathematical processing of averaging and other characteristics of price movements. The instruments of technical analysis are universal and applicable to any Forex sector, any currency and any time span. Technical analysis is easy to compute what is important while the technical services are becoming increasingly sophisticated and reasonably priced. They are available to all Forex participants independent of their trade plans, strategies applied and the time of position continuance.

Dow Theory
The fundamental principles of technical analysis are based on the Dow Theory with the following main thesis:

The price is a comprehensive reflection of all the market forces. At any given time, all market information and forces are reflected in the currency prices (“The market knows everything”).
Price movements are trend followers (“Trend is your friend”); trends are classified as up trends (bullish), downtrends (bearish) and flat (sideways). Examples of mentioned trends are given.
Price movements are historically repetitive (“The history repeats”) which results in the same patterns periodically emerging on the charts.
The market has three trends: the longest (about 1 year) major, or primary, less enduring (1 month and more) intermediate, or secondary, and rather short (several days or weeks) minor. The primary trend has three phases: accumulation, run-up/run-down, and distribution. In this way, in the accumulation phase of a bullish market the shrewdest traders enter new positions. In the run-up/run-down phase, the majority of the market finally "sees" the move and jumps on the bandwagon. Finally, in the distribution phase, the keenest traders take their profits and close their positions while the general trading interest slows down in an overshooting market. The secondary trend is a correction to the primary trend and may retrace one-third, one-half or two-thirds from the primary trend.In frame of a major trend may be any amount of secondary or minor trends. The structure of a bullish trend is shown.
Trends exist until they are broken and their reversals are confirmed. Shows examples of reversals in a bearish currency market. The buying signals occur at points A and В when the currency exceeds the previous highs.
Volume must confirm the trend. Volume consists of the total amount of currency traded within a period of time, usually one day. Large trading volume suggests that there is interest and liquidity in a certain market and low volume warns the trader to close positions. Open interest is the total exposure, or outstanding position, in a certain instrument. Volume and open interest figures are available from different sources, although one day late such as the newswires (Bridge Information Systems, Reuters, Bloomberg), newspapers (the Wall Street Journal, the Journal of Commerce), weekly printed charts ( Commodity Perspective, Commodity Trend Service).

The Best Performance Comes from Candles with Breakouts within a Third of the Yearly Low

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This is true regardless of bull or bear markets, up or down breakouts. The percentages of chart patterns with breakouts within a third of the designated range that showed the best performance are:

Highest third: 5%
Middle third: 11%
Lowest third: 84%

I discovered another trend during chart pattern research that is similar. Here is where breakouts from the best-performing chart patterns with upward breakouts reside in the yearly price range:

Highest third: 27%
Middle third: 32%
Lowest third: 41%

For downward breakouts from chart patterns, the performance list is:

Highest third: 20%
Middle third: 25%
Lowest third: 55%

The results confirm that you should not short stocks making new highs but, rather, concentrate on those making new lows.

A Number of Candles Do Not Work as Expected

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This is the big surprise for candle lovers. A candle that functions as a reversal of an upward trend should cause price to drop. Thus, a close above the top of the preceding candle would be a failure because price climbed instead of fell, whereas a close below the previous low would be a success. Similarly, a continuation candle should have price break out in the same direction as it entered. If price rose into the candle, for example, it should break out upward; a downward breakout would be a failure. How many of the 103 candles I looked at passed or failed according to this method?

Passed: 69%
Failed: 31%

If you listen closely, you may hear the half-glass-full people screaming. Yes, 69% of the candles worked, so let’s discuss additional tests. If I say that a success rate of less than 60% is considered just random, then how many candles worked at least 60% of the time? There are 412 different combinations of 103 candles that acted as reversals or continuations in bull and bear markets. Of the 412, only 100 candles qualified, so the answer is 24%.

If I filter the group by using a frequency rank of 51 or better, then just 10% qualify. The 51 rank is about midway in the list of 103 candles. As a reference, the candle with rank 51 appeared 1,973 times out of 1,204,083 candle lines in 500 stocks over 10 years, including bull and bear markets. In other words, just 10% of candles work at least 60% of the time and occur frequently enough to be found.

If I raise the bar to a 66% success rate (meaning the candle should work as expected in two of three trades) and keep the frequency rank the same, then only 6% qualify. That means just 6% of the candles I consider to be investment grade. Please remember that this applies only to stocks and not futures, exchange-traded funds, or other security types, so the results could change dramatically.

The following lists the investment grade candles:

Above the stomach
Belt hold, bearish and bullish
Deliberation
Doji star, bearish
Engulfing, bearish
Last engulfing bottom and top
Three outside up and down
Two black gapping candles
Rising and falling windows

Dragonfly Doji

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But there’s a problem. Take a dragonfly doji as an example. The candle looks like the letter T with the close at the top of the candle. You would expect price to break out upward sooner than downward just because of where price closes in the candle.

First, the big surprise with such candlesticks is that price does not break out upward the next day. In one test I ran on 20,000 dragonfly doji patterns, it took an average of four days to break out upward in a bull market. Downward breakouts in a bear market took exactly the same time, four days, to make the journey. Yes, the position of the closing price does influence whether a candle acts as a reversal or a continuation, but not to the extent many believe.

Second, if a candle is supposed to act as a reversal, then price should reverse direction, regardless of where it closes in the candle. That’s almost by definition. If you placed a stop-loss order a penny below a candle in a downtrend that failed to reverse, you’d be stopped out. So price should reverse quickly or it’s useless as a reversal indicator.

To be fair, I’m not that stringent. I wait for price to close either above the top or below the bottom of the candle before I determine whether it’s a reversal or a continuation. A hanging man, for example, takes an average of three days to prove it’s a reversal.

Finally, I checked the statistical results, visually, with the candles themselves and found that the method agrees with how I would categorize each candlestick pattern. In other words, if the statistics said the candle acted as a reversal, then it did. If the stats said the candle acted as a continuation, then it did. I used my eyes and counted the results, then compared the results to the stats. Both agree.

Why am I making such a big deal about this? Because 31% of the candles in this book fail. That is, they don’t work as advertised, and many work little better than random chance. There are exceptions, of course, and those are the candles you should rely on. That’s why I wrote this book—to find those gems hidden on the floor of the exchange.

Candles Post Breakout

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How do you determine if a candle acts as a reversal or a continuation pattern? I tested three methods and checked the results visually using hundreds of candles. I chose the best method. Two were variations of an exponential moving average (the price trend) compared to the closing price over time. They were not as accurate or as simple as just looking for the breakout to determine reversal or continuation, success or failure.

An upward breakout occurs when price closes above the top (highest high) of the candle. A downward breakout occurs when price closes below the bottom (lowest low) of the candle. Marry the breakout direction with the price trend leading to the candle and you get either a reversal or a continuation of the prior trend. This is the same method I used with chart patterns. It’s simple,

Candle Performance

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How do you measure candle performance? Since candlestick patterns often lead to short-term moves, I used the closest minor high or low (swing high or swing low), depending on the breakout direction, to gauge performance. The straight-line move often isn’t a long one, but it serves as a good proxy of what you can expect. The statistics in this book should be used to compare results
from candle to candle, not as benchmarks of how well you will do trading candles.

The Price Trend

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Many candles have a defined price trend that leads to the start of the candle pattern. For example, a hanging man appears in an upward price trend, and a hammer appears in a downtrend. How do you determine the trend? I use a 10-day exponential moving average as a starting point and season it with special rules to allow price trends of a day or two to override the result. The method is a bit complicated but it works well. It is, however, not perfect, but the large sample size I use helps.

What Are Candlesticks?

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Let’s talk about candlesticks, starting at the beginning so everyone comes up to speed at the same time. I’ll be brief because most people know what candle charts are. Figure I.2 shows two examples of candlesticks. The line (a single price bar) on the left is a white candle. This one shows the relative positions of the open, high, low, and close. Notice that the closing price is higher than the opening price.

When that occurs, the body is white. On the right, the candle is black because price closed below the open. The upper shadow is hair growing from the top of the candle, and the lower shadow is a single leg dangling from the bottom of the candle. It may help to think of shadows as wicks. Candles don’t need either an upper or a lower shadow. They don’t need a body, either (such as when the open and close are the same). The key concept to remember is that a black candle shows a close below the open and a white candle shows a close above the open. A black candle does not show price closing lower than the previous day, nor does a white candle show a higher close than the day before.
With this candle definition, you can have a stream of white candles in a declining price trend, and black candles forming a rising price trend. I’ve seen both situations, too. That’s all there is to candle configuration. Multiple candle lines along with variations in shadow and body length make up the many candle patterns.

Candlestick

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The candlestick trade I’m about to describe made me enough money to pay for three months of living expenses. That’s not bad for an hour’s work! In a moment, I’ll outline the trading setup so you can tailor it to your liking.

That candle pattern ended the day that price closed above the top of the descending triangle. My research said that the morning doji star is a highly reliable candle formation. Combined with additional analysis I did on the company, both fundamental and technical, the stock was a buy only if it gapped open higher. Why? Because the next day the company was holding a conference
call before the market opened to discuss earnings. A higher open would mean the market liked its story.

The news reports the night before the meeting said that net profit was 53 cents versus 61 cents during the year-ago quarter even as revenue climbed by 30%. Just 1% of the revenue gain was from higher internal sales, though.

Most was from acquisitions or currency translation. Analyst estimates ranged from $0.52 to $0.58, so earnings came in at the low end. All of this sounded bearish to me, but the technicals were shouting, “Buy!”