Finding Good Entries in Forex

03/16/2011 1:01 am EST

Focus: FOREX

Traders in all markets can better identify low-risk, high-reward entry points by looking at two distinct indicators on the charts: moving averages and Fibonacci retracements.  

By Rick Wright

This article is about the spot forex market specifically, but it relates to trading and charts in general as well. Very often we will be watching a particular trading instrument and can't seem to figure out why it is trading the way that it is. Many of the Lessons From the Pros newsletters have already discussed the idea that previous demand and supply zones will give us the lowest-risk/highest-reward entry points. In fact, several recent newsletters have discussed how to measure the quality of these different demand and supply zones. However, there are times when a particular move in a currency pair doesn't seem to make sense when looking at the level that is causing it to stop dead in its tracks. So what could cause this pause? Elementary, my dear Watson!

There are a couple of other indicators that traders watch when trying to determine a "good" location to enter or exit a trade. One that I will discuss today is the moving average (MA). As I've stated before, there are as many different moving averages and techniques that go with them as there are traders out there, but here is an easy way in which I use them.

On a daily chart of whatever it is I am trading, I take a look at where the 50- and 200-day moving averages are. In fact, you may want to look at both the simple and exponential MAs for the 50- and 200. In my opinion, they seem to alternate which is being "used" by the big boys who move the market.

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Watching the EUR/USD on this 120-minute chart, why did it choose zone 1 to stop and reverse from? Why didn't it get down to the more obvious zone 2? If you were waiting for zone 2 to be hit before entering a long trade, you missed it! However, if you were aware of the moving averages I mentioned earlier, you may have taken the long trade.

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Notice how the EUR/USD has been reacting to the 50-day exponential moving average (EMA) on the daily chart for the past few weeks. (I removed the 200 EMA and 50- and 200-day simple moving averages (SMAs) for clarity of the picture.) At each of the indicating arrows, our currency pair reversed direction for several hundred pips! Obviously, it doesn't do this every time it touches this moving average, but being aware of where we are in relation to it is a good idea.

When we use the combination of the demand zone and the moving average, we can plainly see that we have a higher-probability trade on the screen. In fact, looking to the left on the chart where the arrows are pointing, you can see a supply level that worked a few times until it became a demand level for us. A very common question in our Online Trading Academy classes is, "Can I use moving averages by themselves?" The answer is yes, you can; however, having a clear understanding that supply and demand zones will give you lower-risk/higher-reward trades is more important than using a simple indicator to trade from.

The second tool I'll demonstrate is a simple Fibonacci retracement. For clarity's sake, I removed some of the previous chart's notations:

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So, in addition to having the 50 EMA showing a bit of support/demand, we also have two different Fibonacci retracements lining at the exact same level. The blue Fibonacci is the 38%, while the pink is the 68% (often called nested, layered, or clustered Fibs). So the point, my dear Watson, is you have no less than four reasons to go long at that level, and at least three chances to get long! If you need more than four reasons or three chances, I think you need to go back to class!

So there you have it: By looking at the bigger picture and at multiple reasons, you can identify what could be a major reason to choose this particular level as the one that will hold.

By Rick Wright, instructor, Online Trading Academy

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