When you’re trading Forex, strength and weakness agreements have a tendency to come in handy. One of my favorite indicators for tracking strength and weakness patterns is the ADX. Today, we’ll cover ADX trends and their respective strengths and weaknesses, and an example of ADX weakness in time, on consecutive charts.

That’s some of what’s on today’s video on ADX Trends:

So the first thing you need to have a trend showing on the ADX is for there to be strength showing on a move. If the market moves lower and the ADX increases, that’s a stong move down, and the first step needed to have an ADX trend.

The second component needed is for the market to retrace some of the strong move, and have the ADX decrease, saying that there’s weakness in the counter-strength direction. So if the market moves lower and the ADX increases showing strength, then the market moves higher with the ADX decreasing, that’s the second part of having an ADX trend.

The third and final component is for the market to move farther in the direction of the prior strength.
Then there is an ADX trend on that chart, and that trend is either strong or weak.

In a strong trend, the ADX moves higher than it was at the end of the strong move in the same direction. In a weak trend, the ADX does not move higher than it was at the end of the strong move in the same direction.

Example: The market moves down, the ADX increases - shows strength in moving lower.
The market then moves higher, and the ADX decreases - shows weakness in moving higher.
The market then moves farther down than it was before the retracement up began.

That’s an ADX trend, and it is either strong (if the ADX is also higher than it was as the market moved farther), or weak (if the ADX does not move higher than it was as the market moved farther).

That’s it on the ADX trends. If you have any questions or comments, please leave them and I will get back to you as soon as I can. Have a tremendously successful trading day!

Yes, Risk and Money Management is that important when you’re trading Forex.

The basic risk and money management model is quite simple: it’s just the “previous peak take-out point” type of strategy that, over a sufficient amount of time, has proven itself profitable. That profit is made in trending markets, where the market keeps moving in basically the same direction. The losses incurred using just the basic model can be disheartening and frustrating, incurring many losses in a row, and quite often unacceptable.

The big “but” here is that it is NOT the system, it is a very basic model that will be built upon. Like any other basic models that are intended to be built upon, like any other foundation in any building that is intended to be built upon, it is not the final structure.

Imagine for a moment that you pay someone to build a house for you and stop by one day and there’s only the foundation in place. You wouldn’t immediately assume that you’re going to be moving in as is because the rest of the house isn’t there yet.

This is the same type of thing: this very basic model is only a foundation, and the rest of the pieces to build the full “house” are not in place. Without a strong foundation, the house will not long stand. This foundation is prime to be built upon.

In getting started with the very basic model, you will notice on the chart below that there are no indicators on the chart. All that is there are the bars for one time frame.

The “bars” on the chart above are called “Open-High-Low-Close Bars” or “OHLC bars” because on each bar there is a point which represents each of the Open, High, Low, and Close. The tick on the left side of each bar is the opening price for that bar. The highest point on each bar is the highest price the market reached during the time period of that bar, so the highest point on a bar is the high. The lowest price level on a bar is the low for that bar. The tick on the right side of a bar is the closing price for that bar.

Each bar represents the market action during the time period of that bar. The above chart is from a 5-minute chart, so each bar represents the market action during a five-minute period.

There are other types of charts, but this type, the OHLC bar chart is, in my opinion, very good and very useful, and there is not necessarily any more information on any other type of chart.

What is important about this type of chart is that we can see what are called “peaks”. In order to understand what a peak is, we have to define the characteristics of peaks and see what they look like in their various forms.

A “peak” is defined as “a point or plateau which exceeds the previous and next bars’ same-side extreme.” You can get the idea from looking at your pen and holding the point so it is facing up. You can see that the high point in the middle is higher than the left and right sides. If you then hold the pen upside down, you will see that the point is lower than the left and right sides.

Below you can see a chart with all of the peaks marked except one (can you find it?):

The grayed-in areas show “plateau-type” peaks, where the market hit the same price point during two or more consecutive bars and that price point extends beyond the extreme of both the left and right sides of that plateau. (Can you find the one plateau-type peak which is not grayed? There is one.)

After studying the above chart for a few moments, you can really see what a peak is and what does not constitute a peak. If you do find what you think is a peak by definition, but it is not marked, look for yourself to determine why it is not a peak (except for the one that is not marked).

Also note that it is impossible to have a peak in present time. In other words, there can be no peak in real time, right now, because there is no “next” bar for the current bar to be more extreme than. So in real time, there is never a peak “right now”. That’s a very important point to know.

Now that you know what a peak is, what is a “previous peak take-out”? What we’re talking about here is a previous peak on the same side, and the current bar, the “now” bar in real time, moves at least one tick farther in price. If we’re on the top side of the chart, then we’re looking to see if the market moves higher in price than a previous peak. If we’re on the bottom side of the chart, then we’re looking to see if the market moves lower in price than the last peak on the bottom side, or lower on the chart than that previous peak.

As soon as a new peak forms on the same side, that new peak becomes the last peak, or the “revious”peak. That peak two peaks ago becomes a previous peak, but not the previous peak. Please note that distinction, because later on it will be crucial to your understanding the difference between when I write the previous peak, and a previous peak. The is more specific, and a is general.

Since this “foundation” is the previous peak take-out point, it is the specific form.

So in starting out the foundation with no indicators, we are only relying on previous market peaks on one chart, one time frame, to tell us what to do – in this basic model, which we will not be using as it is directly, but are using to build from – and the chart on the next page will show the previous peaks, and when the previous peak was taken out, at what price level.

[Note that there is version of this basic model that is a previous peak take out, and the basic difference is that any old peak on a side that the price extends beyond, you trade in that direction as long as the peak is wide open to the price. “Wide open to the price” means that from the peak in consideration to the current bar there are no price bars (or candlesticks if you’re using candlesticks) in the way if you were to draw a line from the past peak to the currrent price bar.]

Please pay close attention to the previous peak, and when it was taken out, or the price moved beyond the previous peak’s extreme point. Each sequence is in a different color, so it shouldn’t be too difficult to figure out which goes with which. So look on the next page now:

From each “Previous Peak Take-Out Point” there is marked “The Previous Peak”, and in real time, it was that way. Notice that there are more of “the previous peak”s that were also taken out, or where the price moved beyond that level, but I want you to understand the concept. You should feel free to mark up where “the” previous peak was taken out by a market move to help you better be able to apply the basic information.

Great, so now we have what a peak is, the difference between the previous peak and a previous peak, and what it look like when the previous peak was “taken out” and what it means to have the previous peak taken out. So, what do we do now? How do we use that?

We use the previous peak in this basic model to get us in the market in a direction – in this basic model only. We will not be actually using this exactly as stated, but we will be building upon this basic model, this basic foundation, to be building upon.

What we do in this basic model is to let the market form a range, a peak on both sides of a chart, like the 5-minute chart, then we let the market enter us in a trade by setting the stop orders on both sides of the range defined by the peaks.

So what we do when the market has shown us a high peak and a low peak is to then set a buy stop for one contract above the high peak, and a sell stop for one contract below the low peak. How far? One tick beyond each peak. The buy stop is placed one tick above the high peak, and the sell stop is placed one tick below the low peak.

The Market Open is marked with the green line. After that line, the first market peaks are formed. When both are formed, you place a buy stop one tick above the first high peak, and a sell stop one tick below the first low peak.

When a new peak is formed on the bottom side one bar after the first high peak was formed, you move your sell stop to one tick below the new low peak and cancel your first sell stop, which was not filled because the conditions were not met yet.

Notice the red dot above, which shows where your sell stop was triggered, where the conditions were satisfied for your order to sell at that point. What this means is that you have sold one contract, assuming you are trading a futures market, and that means that you are now one contract “short”. Short means that you sold first looking for the price to move lower so you can then buy at a better price, a lower price, later on. So you are now short one contract, and your buy stop is now one tick higher than the second high peak.

Right after the market filled your sell stop, you are in a short position, you now change your buy stop to 2 contracts instead of one contract. What that does is to take your stop loss (the buy stop above the market, where you say you are now going to stop taking a loss on the position) and when it is triggered, you will now be long one contract. Being long one contract means that you have purchased one contract thinking the market will move higher in price so you can then sell your contract for a profit.

So in this basic strategy, you are always in the market either long or short. You always have an open position until near the end of the day once your first position is filled. The major plus of this strategy is that you are always protected with a stop order. The major negative is that on wildly swinging days, there would be considerable losses incurred.

You continue to move your stop orders for two contracts as new peaks are formed throughout the day until you close your final position near the end of the day. When you close your final position near the end of the day, you will do so by placing a market order directly against your final position. So if you are long one contract, you will sell one contract. If you are short one contract, you will buy one contract. That closes out your open position near the end of the day.

Your first exercise for this basic strategy is to mark and write down what would have happened on this particular day. Would you have been profitable or not? (Answer: Profitable.)

While this basic strategy works well on trending days, on non-trending or wildly swinging (whipsaw) days, the wins will tend to turn to net losses for those days.

Your next exercise for this basic, foundation-only strategy is to actually paper trade it for a day or two on a 3- or 5-minute chart in the market of your choice. Once your first trade is filled for the day, you should always be in the market either long or short until very near the end of the trading day’s regular trading hours (on most markets), or most active times (if a 24-hour market, like the FOREX). You must be able to think with the basic mechanics of this basic system, even though it will not be used directly in the full model. You should understand the mechanics of the previous peak take-out model – regardless of whether or not it is profitable for the day(s) you are paper trading it – before you progress to incorporating the basic add-on model, which follows. That means that if you are relatively new to trading, you will not have any indicators on your chart(s). You will only have the market action with a 5-minute OHLC bar chart representing that action.

[If you’re already very familiar with the basics involved and can follow it without hardly thinking, you may feel free to move on to the basic add-on model.]

So, how can we take this basic model and make it so we can make even more on the trending days than we lose on the non-trending or wild days?

When we look at the trading rules, we see rule number three: Let your profits run and multiply as safely as possible. Without the multiplication aspect, we are only making linear profits and losses, zig-zagging on either side of net profit and loss, with a long-term, gradual increase in account size. That is an undesirable condition. I certainly don’t tolerate it, and this leads us to the basic add-on model. You might just like this one really, really well because over time it’s usually very profitable when sticking to the rules.

No pics or video today. Just the rules. Keep in mind that you have to be using an oscillating indicator to use divergences. Examples of oscillating indicators are MACD, Smoothed RSI, Smoothed ROC (Rate of Change), Slow Stochastic… And you must have the ability to look at multiple time frames. We won’t be using add-ons in this basic model. Those are for another time.

The purpose of this is to give you a simple, basic trading system that you can practice managing on paper.

I won’t here get into the risk management or money management aspects, but will on another post. Just pretend it’s one lot and your account is big enough to take the loss from peak to valley, or valley to peak of the trade. (I use 2/3% account as unit size - yeah, I’m a chicken, but I never risk more than 2% on any position, so…)

0. Peaks and valleys are found on the largest weakness chart in the sequence, just below the smallest future strength chart. If you’re on the 60 minute chart, the next smaller chart is the 20-minute or 15 minute. The next bigger chart is the 3 or 4 hour chart, where one bar represents the price action of a 3 or 4 hour period.

1. See if there exists larger chart future strength divergence, combined with at least 2 smaller chart past weakness divergences that say the market looks like it wants to reverse recent price direction. On the larger chart, the trend direction must be the same direction as the trade. (If you don’t know what I said for this rule, go back to an earlier video in this series.)

2. If not, there is no order placed.

3. If so, choose the closest peak (if future strength direction is up) or valley (if future strength direction is lower), and set a stop just beyond the peak or valley. If long, be sure to add in the spread for the currency pair, too. The stop for the trade is the opposing directions last peak or valley.

4. When you’re in the trade, and the market moves beyond the next peak, move your stop to just beyond the last opposing peak or valley.

5. Once the market moves farther in your direction, moving past 2 peaks (or valleys, if you’re short) which were made while you have been in the trade, tighten the heck out of your stop, or exit. (Only choice you get.)

And that’s it.

Practice well, and have a phenomenal trading day.

This post on Divergences is VERY concise. Every sentence has actual meaning and use. “Peak” below means either peak (high) or valley (low).

A divergence is a discrepancy between market action and indicator action. There are only two types of divergences:

1. The market moves farther in a direction and the indicator does not move farther in the same direction, and
2. The indicator moves farther in a direction and the market does not move farther in the same direction.

To see a discrepancy, we have to look on the same side of the market and the indicator. So if we look on the top side of one, we must look on the top side of the other. If we look on the bottom side of one, we must look on the bottom side of the other.

The discrepancies can only occur on the top side and the bottom side of the market and indicator.

When we see a discrepancy on the top side, that is a signal that the market could move down.

When we see a discrepancy on the bottom side, that is a signal that the market could move up.

When the market moves farther in a direction and the indicator fails to move farther in the same direction, then that is a sign of weakness in the direction that the market moved. So, discrepancy (1) above is a sign of weakness in the direction that the market moved farther in.

When the indicator moves farther in a direction and the market fails to also move farther in the same direction, then that is a sign of strength in the direction such signal says the market could move. So, discrepancy (2) above is a sign of strength in the direction the signal tells us the market could make a move.

Condition one to having a signal is that there be a discrepancy between market action and indicator action. That discrepancy will always be one of the two types above, on the top or bottom.

[NOTE: A signal on a chart is meaningless outside of what is called a “line-up”. Line-ups will be covered later in the training.]

How to Determine if a Divergence Exists

To actually have a signal from a divergence,

1. one must begin at either
   • a market peak or
   • an indicator peak

   farther back in time and move toward present time (to the right on a chart).

2. From that beginning peak one draws a line from the market peak and/or indicator peak to the market’s “now” point at that time if one is drawing on charts that have already occurred.

If one is actively looking for divergence signals in real time, it is impossible to have a market peak in real time “now”.

Reason: a peak, by definition, must be beyond the previous and next bar. Since there is no next bar right now, “now” can never have a peak. Therefore, we must start at a market or indicator peak in the past. That’s condition two – the starting point of a signal must be at a market or indicator peak, and that must be left of where we are drawing to.

The Third Condition to Having a Real Divergence

Condition three to actually having a signal is that over the exact same time period from the starting point (market or indicator peak) to our “now” point, we may not draw the line through either the market action or the indicator action. On the market, the bars representing market action act as a barrier. On the indicator, the indicator line itself acts as the barrier.

When all three conditions are filled, we have a divergence signal.

If all three conditions are not filled, we do not have a signal.

IN SUMMARY: Over the exact same time period on a chart, we may not draw a line through the market or the indicator to get to our “now” point. A discrepancy (1), where the market moves farther in a direction and the indicator does not move farther in the same direction over the same time period, that shows weakness in the direction the market moved farther in.

In a discrepancy (2), where the indicator moves farther in a direction and the market does not move farther in the same direction over the same time period, that shows us strength, or coming strength, in the direction the discrepancy (2) says the market could move. All three conditions must be met to have a signal. If all three conditions are not met, there can be no signal on that chart at that time.

Please note that I have a horrible storm system just a few minutes away from me as I finish the typing. I will have a video for you showing you everything above (and probably even a little more) tomorrow.

Added 2008 June 11:

Sorry I’m not a video expert, but what the heck. I’ll get better with more practice. Leave me comments and questions and I’ll answer you!

Kick it with your own forex trading.

I hope that this helps you. Have a truly phenomenal day!
Russell