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Evaluating Probabilities Using Technical Analysis

 

T
he probability evaluation technique is based on common market laws and is conducted in accordance with technical analysis rules.

It is clear that, at any given moment, the probability of the mar- ket moving in one direction or the other in the future is unequal. Also unequal is the probability of a possible profit or loss receipts on any po- sition taken. This probability depends on many factors: time of day, se- quence and amplitude of the previous fluctuations, long-term and short-term trend directions, current technical picture, direction and speed of market’s movement at the present moment, and other factors. The various combinations of these factors can be identified, classified, and serve as the base for constructing standard models of the market behavior.

After this preliminary research is done, selecting effective tactics for each concrete trade should not be too complicated. If you know and are able to identify these laws, objective probability evaluation will replace the necessity of having your own opinion about future market behavior. Therefore, each new position taken by a trader in the market, from the moment of its opening, has to have a considerably high probability to be- come profitable rather than unprofitable.

For an initial and rough estimation of a direction probability of the next market movement, I mostly use technical analysis with the exception of those elements that I consider insignificant or insufficiently accurate. In particular, I do not use any indicators with the exception of MACD and RSI; the only purpose of their use is to identify divergences on daily, weekly and monthly charts. See Figures 8.1 through 8.4.

 


 

 

 

FIGURE 8.1 USD/CHF Daily chart picture. It is a sample of bearish divergence on the RSI indicator.

 

 

 

FIGURE 8.2 This is another bearish divergence. This time, it is shown on the MACD indicator on the USDX weekly chart. As you can see, it worked exactly as it was supposed to, despite the fact that the major trend is up.


 

 

FIGURE 8.3 One more chart and one more bearish divergence against the trend. The correction, though, wasn’t big enough to reach the bottom of the previous dip.

 

 

FIGURE 8.4 Here is an extremely important and interesting picture. A bullish triple divergence seen on the monthly USD/DEM chart and the MACD indicator gives a very strong signal in favor of a major trend reversal after the downtrend, which lasted for many years from its 1984 acme to its end. This divergence probably indi- cates the final turn into a major USD uptrend against all European currencies.

 


 

 

Besides technical analysis, I also use simplified statistical analysis made on the basis of long observation of the market behavior and study of its common laws. Many laws can be quite well explained from the com- mon sense point of view, as well.

Such preliminary probability evaluation allows me to avoid the most common mistakes at opening and liquidating of my positions. The crite- ria follow.



 

• Usually, the probability that the market will continue its current movement in the present direction is higher than the probability that the market will soon change direction to the opposite.

 

Because the market has a high degree of momentum, the logical con- clusion would be that opening a position in a current prevailing direction already gives a trader some statistical advantage of making a profit, rather than having a loss in such a case. However, even though it directly follows from one of the basic postulates of the technical analysis (the market moves in trends), many traders prefer to search for the opportu- nity to catch the moment of the market transition from one direction to another, instead of going with the trend. My own observation shows that many novices intuitively feel this law and open the majority of their posi- tions (in the very beginning of their trading careers) in a direction of a current market move. In fact, the less theoretical knowledge and practi- cal experience a beginner has, the more expressed such a tendency is. Al- though they don’t yet feel capable of predicting future changes in the market behavior and don’t try to do so, they base their trading on what they see on the screen.

Because the FOREX market has a very high volatility, often such a tactic is justified and brings novice traders success during the initial pe- riod of their trading careers. This is why the overwhelming majority of the novices succeed while practicing dummy trading or even trading with real capital in the beginning. Unfortunately, this ability to go with the market soon disappears. Then it becomes substituted with analysis, mostly in ac- cordance with knowledge received from books. Instead of simply follow- ing market fluctuations, traders begin to predict its future behavior and try to act in advance. From that point on, the majority of new positions are based on analysis and forecasts, and very often against the current market movement. From the moment strategy is shifted to mostly picking tops and bottoms, the chances to survive in business are sharply lowered.

From my point of view, the formula “sell on weakness, buy on strength” has an obvious advantage over another popular formula “buy low, sell high.” The latter better fits a longer-term trader or investor rather than a short-term speculative trader, whose basic purpose is to enter and


 

 

exit the market fast enough to get a relatively modest profit and then to secure it. In real trading conditions and especially in a day trade, it is much more difficult to define a point or even an approximate zone of a market turn, than to receive fast profit, catching the market on the run and opening a position in a direction of its current movement. Therefore, any trade tactics providing a position opening in a direction of movement (that already has begun) can be considered preferable in comparison with tactics focused on picking extreme market levels (tops or bottoms) to open a position against the prevailing direction at the moment.

 

• If the market had committed a significant move in some direction during the day, there would be a high probability of some extension in the same direction during the next day. The same assumption can also be used for analysis of weekly and monthly charts. See Figures

8.5 and 8.6.

 

The trend is one of the main market’s features and occurs frequently. There is nothing unusual in this fact, and the FOREX market is famous for

 

 

 

FIGURE 8.5 This is a very impressive sample of my statement: A strong and volatile move in one direction, with the closing price of the day almost at the very bottom of its range, continued during the next day. Despite the fact that the volatility of the third day was big, the closing price was closer to the top of the day than to the bottom, and therefore, no further extension is seen.


 

 

 

FIGURE 8.6 This picture illustrates the same assumption as that in Figure 8.5, but in a bigger time frame.

 

 

its trends. Simply looking at the charts you can relatively easily identify the day, week, or month when a movement has begun. Such a period is characterized by the prevalent tendency in one or another direction and by an essential difference between the opening and closing prices of each bar on the charts. See Figure 8.7.

While conducting simple statistical analysis of daily and weekly charts at the end of each trading day and week, pay attention to the closing price of this day or week. If the market closed near the high of the last bar, there is a great probability, that the high of the following bar will be even higher. See Figure 8.8.

If the market closing price was almost on the low of the bar, then most likely that low of the following bar will be even lower. See Figure

8.9. Because gaps on the FOREX market’s daily and weekly charts are very rare, the open price almost never coincides with the future high or low of the bar.

For example, if the day’s closing price was near the high, on the next day the probability of a repeated attempt to reach and exceed the previ- ous day’s high would be much greater than the downward market move- ment. In other words, the market usually trades in both directions from


 

 

 

FIGURE 8.7 An acceleration of a downtrend on the EUR/USD weekly chart indi- cated by a significant difference between open and close prices of each consecu- tive bar.

 

 

FIGURE 8.8 Typical uptrend sample. Each closing near the top of the weekly bar with an above-average range statistically leads to a continuation of the move in the same direction.


 

 

 

FIGURE 8.9 In the case of a downtrend or fast and deep correction, each clos- ing near the bottom of the weekly bar with an above-average range leads to a con- tinuation of the move in the same direction.

 

the day’s open price, but the main direction of the day is mostly the same as during the previous day.

It is also important to keep in mind that if a trend is present, the aver- age number of consecutive days on which the closing price of the day is lower or higher than the opening price is four. In my memory, the highest number of consecutive positive or negative day closings was nine.

 

• The purpose of technical analysis is not to predict where and when the market will go, as many traders think. The main goal of analysis is to define in advance the critical points or levels. Then, based on this research, you can build a trading strategy for the next trade.

 

 

  END-OF-THE-WEEK AND END-OF-THE-DAY ANALYSIS  
   

 

Creating and improving my trade method, I have developed a routine pro- cedure of market analysis. The research is made regularly and always pre- cedes any real actions on the market. This procedure provides me with the preliminary analysis of a current market condition at the end of each


 

 

trading day. It begins with definition of key points, critical zones, supports and resistances, and also includes preliminary and rather rough probabil- ity evaluation of the main market direction during the next day. At the end of each week, I do such analysis for the whole next week, too. Despite the fact that this part of the chapter is large in volume and contains many steps that a trader needs to take before he completes his daily routine analysis, the actual time you will spend on the daily procedure is unlikely to exceed 15 to 20 minutes.

 

 


Date: 2015-12-17; view: 852


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