GBP/USD Headed Up from Consolidation Support

01/14/2010 12:01 am EST

Focus: FOREX

Consolidations. Scalpers and short-term momentum players love 'em, while trend followers absolutely loathe them, particularly the ones that take every entry signal, regardless of external confirming factors. Eventually, however, consolidations end, usually with a noticeable breakout move out of the range, and that's when the trend-following crowd normally gets to earn their keep. Let's examine the daily chart for this currency pair and see if this is a long trade setup worth consideration.


Click to Enlarge

The British pound/US dollar currency pair are still trading within a broad range between $1.5740 and $1.7000; note how when the 50-and 200-day EMAs go flat, with little spread between, the existence of a trading range is confirmed.

In the chart above, the dashed gray lines delineate the broad trading range market that has existed in this currency pair for approximately seven months, and as of this writing, there is no reason to believe that this period of consolidation is about to come to an end anytime soon. Since none of us can accurately predict the future on a consistent basis, it behooves us to trade what we see on the chart, rather than what we believe may, may not, or should, happen.

The GBP/USD cross has likely put in a daily cycle low as of December 30, 2009, and is now in the process of forming a minor double-bottom pattern. Since the tentative second low of the pattern is higher than the first, and is also above the broad trading range low of $1.57075 (made on October 13), the line of least resistance appears to be higher, at least until the pair collides with either the 50- or 200-day exponential moving averages (EMAs) near the $1.6250 area. Should this current, daily-based upswing eventually close above either and/or both of those EMAs, there is a good chance of some further follow through, perhaps toward the upper boundary of the broad trading range, which is at $1.65–$1.70. There are several prior swing highs that should offer overhead resistance en route to that upper range line, so expect to see plenty of back and fill price action, even if this currency pair is destined to eventually break out en route to substantially higher prices.

This chart also is a wonderful educational tool inasmuch as it depicts one of the best ways to confirm the existence of a trading range market, using nothing more complex than the relationship of the 50-day EMA to the 200-day EMA. Note how when both averages go flat and have a very tiny spread between them, that the market is simply oscillating back and forth in little waves that are a swing trader's dream come true. Sure, you still need some sort of a timing tool to get you in and out of such trades, but with practice, you may find that once you can successfully identify the existence of a 50- to 200-day trading range market (with flat EMAs and very tiny spreads), the timing of such trades is a straightforward affair.

If you can locate setups with approximately a 2:1 risk/reward ratio, you stand a better chance of realizing consistent profits. In the trade setup shown, setting an initial stop just below the recent low at $1.5900 and then projecting a profit target at the 200-day EMA at $1.6250 also provides close to a 2:1 risk to reward ratio, assuming an entry fill of $1.6020 or better. If such a fill can be obtained, the trade would be considered low risk. As I write this, the pair is already trading at $1.6070, a little beyond what would be considered an ideal entry price to go long. However, if your own analysis leads you to believe that the pair is going substantially higher, getting a fill at this price shouldn't pose too much of a problem.

The global currency markets trade 24/7 from Sunday evening until Friday evening, offering a steady stream of trading opportunities for well-prepared traders. With margins ranging from 20:1 all the way to 200:1, you can be sure that well-capitalized traders will feed off of those who open a forex account with a mere $500 in hopes of outwitting and outlasting the pros who tend to own this niche of the trading world. So if you want to trade forex, may I suggest that you learn all you can about simple, low-risk trading strategies and then paper trade these strategies using a trading simulator like those found at Interactive Brokers, PFG, TradeStation Securities, thinkorswim, or any number of forex brokers, for at least six to 12 months before you risk a dime of real trading capital.

You'll find it to be a terrific learning experience, one that may save you many thousands of dollars in needless trading losses and emotional frustration. Once you're able to generate consistent profits, consider funding your forex account with at least $5,000 to $10,000 at a minimum, being sure to fine tune your trading strategy until you have 100% confidence in it.

It should be well worth the effort.

By Donald W. Pendergast, Jr. of ChartW59.com (www.ChartW59.com)

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