Forex – Happy Doji Hunting

FOREX trading is the 800 pound gorilla in the investment world with more than 3.9 trillion in currency trading taking place per day, according to the Bank for International Settlement. There is more daily volume in the FOREX market than in all of the US stock markets combined.  We hear and see information daily on the values of currencies on CNBC, Bloomberg, and print journals such as the Wall Street Journal or Investors Business Daily. Analysts and investors talk about the many effects currencies play in everyday finances one of which is the bottom line for multinational corporation’s earnings.

One impact that currency value fluctuations has is on our export business, particularly in the grain markets. Exports may rise from a weakening dollar but at the same time affect import prices of some products. Now, more than at any time in the past, mainly due to the information age, investors are more aware that trading opportunities in foreign currency exists. It is this awareness that the explosion of popularity for the Forex markets has been born. The Forex markets offer free commissions, no exchange fees, on-line access and plenty of liquidity. Investors are attracted to the perception of “free trading”, (most firms charge a bid/ask rather than a traditional commission). One more attractive feature is that most FOREX Firms required less capital to initiate a start up account.

There is demand, there is volume, there is access, and there are plenty of major players in the game as described to provide liquidity. But how can one trade it. Do traditional technical analysis methods work? Yes, in fact there are sophisticated traders, software and specially produced programs just for Forex markets. I believe that individual traders do not need the heavy artillery computer programs to trade FOREX. Since Forex trading takes place around the clock. Traders can watch the markets from the office and then at their home computers.

In the book “A Complete Guide to Technical Trading Tactics, How to Profit Using Pivot Points, Candlesticks & Other Indicators, I educate traders how to combine certain candlestick patterns with Fibonacci, and specifically employing the use of Pivot Points. These techniques are extremely useful for FOREX traders. This technique not only can help a trader develop a reliable trading system, it is a great way to improve ones discipline and focus on a trade.

First, let’s review what Pivot Points are and how I formulate the data used in my trading approach.

Pivot Point analysis is derived from mathematical calculations. These calculations rely on specific time frames in determining support and resistance levels for that timing element. I use several time frames such as Monthly, Weekly and Daily to help me determine a projected level of support and resistance. I give more importance when two or more time frames coincide or line up.  For traders using Pivot Point analysis in forex markets there is a big discussion on when to assign a closing value. Some use the 12 PM close to determine one day to the next. In real terms since in the spot forex market all trades must be settled with-in two business days, which is established at the close of banking business at 5 PM (EST), that is the time period I use for determining the closing value for my numbers.

The pivot point number is the high, low; close added up and then divided by three.

P= (H+L+C)/3= pivot point

 

First resistance level take the pivot point number times two and then subtract the low.

(Px2)-L= resistance 1

 

For the second resistance, take the pivot point number add the high and then subtract the low.

P+H-L= resistance 2

 

For the first support take the pivot point number times two and then subtract the high.

(Px2)-H = support 1

 

For the second support, take the pivot point number subtract the high and then add the low.

P-H+L= support 2

 

I use these values to help me predict what might be the High, or low or simply a spot from where the market may make a change in price direction. That prediction element allows me to prepare for a trade. I then look for specific candle patterns to help me trigger into a position based on a certain trading tactic.

The components of a candlestick are derived from the Open, High Low and Close. The main components that we need to identify are the relationships between the Open and the Close of a session which is termed the candle’s body. The shadows and correlations or distance and depth they have to the candle’s body and the overall range or length of the candle. A higher closing than open candle is generally hollow, white or with most software programs today will be green colored. A lower close than the open candle is a dark, black or red colored body. Remember, candles do not indicate whether they closed higher or lower than the preceding time period rather they depend on the close in relationship to the open.

One such trading tactic is what I describe as the High Close Doji pattern.  First let me expand on the mystique and my theory of how a Doji is formed.

Doji’s indicate indecision, the market ends where it began. Confidence is lost from buyers or sellers from the open as the market made a lot of intraday noise as the range was established. In a bullish or bearish trending market, indecision is the last thing you want to see. Strong rejection or failure from the high and or low is a significant tell-tale sign that changes are coming.

In a strong down trending market usually the market will close near the low as larger capitalized traders will hold or add to short positions overnight. If the large money traders are not confident the market will close lower in price, then the market may have the tendency to close back near the open. Doji’s help form two and three candle formations that can develop into more powerful and trust-worthy signals once identified. One such formation is the Morning Star pattern.

The Morning Doji Star is a major bottom reversal pattern that is a three candle formation. The first candle has a long black real body (lower close than open); the second candle has a small or no real body that gaps lower than the first candles body. The third candle’s body sometimes gaps higher than the second one but does not happen often. It is important that it is a white candle (higher close than open) and closes well above the midpoint of the first candles real body.

It is important to note that there are several variations to this text book description. It may be hard to see the long dark candle or if the long white candle closes above the mid-point of the first candle.  What is not hard to see is the Doji. It stands out and separates itself from the other candles. It is also not hard to see where the next closing period is. That is the one most important element that triggers this trading tactic. It is not in the ability to successfully identify a Morning Doji Star, it is the ease in which to identify a doji and then understand what the next time period’s action is. Doji’s indicate indecision, in a down trend once the Doji forms and especially near an important support target such as a Pivot Point support level, my level of awareness is heightened. This is one of the most powerful set-ups for a trade.

To trigger the entry I want to see a higher close above the Doji’s high where I would want to buy on that close or the next time periods open. In effect, this is a confirming closing breakout and as such, positive momentum should develop immediately or within a few time periods after a higher close occurs above the Doji’s high.

Lining up the Pivot Points on my screen prior to the trading session prepares me for when a set-up like a doji or Morning Doji Star pattern develops.

Your risk management strategies could include a set value stop such as 120% of the average daily range for the last ten periods and then place your stop-loss order by that amount below the Doji’s low. You could also use a Stop Close Only below the Doji’s low for the specific time period you are trading in. There will be times that you have to make a judgment on whether or not the risk is too excessive by the distance of the proposed entry and the Stop close only.

This method works for all sessions and different time periods I find the 5, 15, 30 and 60 minute time periods valuable when charting the FOREX markets. This method works for all foreign currency markets.

Good luck and happy Doji hunting.

Author: John Person – 2005