Don’t Forget to Pack All Your Tools!

08/07/2007 12:00 am EST

Focus: STRATEGIES

Timothy Morge

President, MarketGeometry.com

I still remember my father telling me, “You can’t use a wrench if you left it at home, son. Always bring all your tools with you when you go to a job.” My father was a welder. I’m a professional trader. But bringing all your tools to the job at hand is just as important to me, and all traders, as it was to my father.

But when I say  “bring all of your tools,” I don’t mean throw every new multi-derived curve fit oscillator whizz-bang on a chart when you’re ready to trade. I mean the tools you are familiar with, the tools you have mastered. And tools you may not think of as tools, like solid money management, risk reward ratios and simple profit target projection tricks that help you lock in profits. Sometimes the best tools are sitting between your ears—if you remember to pack them and then when the time is right, take them out and use them!

Probably the most active market is the cash foreign exchange market. The total amount of currencies traded every day dwarfs the value of all the stocks traded in one day, all the options traded in one day and all the futures traded in one day. In fact, it’s currently officially estimated that the cash volume being traded in foreign currencies worldwide is more than 10 times as much as the total cash volume being traded in all equities [stocks and options] worldwide! Currencies start trading on Sunday afternoon in the United States and trade continuously until late Friday afternoon. And because any time money flows from one country to another, currencies are traded—so there are plenty of opportunities to take advantage all the time in the currency markets.

Let’s take a look at one of the most active currency pairs: The Euro versus the US Dollar. I’ll be looking at simple 20 minute charts that cover the entire 24 hour day. The Euro had been gaining in value against the US Dollar all summer long and then in late July, a sharp sell off began. After several days of sharp losses, the Euro began to regain some ground on the US Dollar. Let’s take a look at a chart of that action now:

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The Euro/USD has been in a nice down trend. After a near vertical fall of 133 pips, price has congested a bit, re-tested the low price made during the recent fall and has now begun to make higher highs and higher lows as it heads a bit higher.

I added a red down sloping traditional Median Line drawn from the high of this most recent move down using the latest swing high as Pivot C. This should give me a good feel for the direction of this market. The Median Line is a line of force and it projects forward in time and space the rate of rise or fall of price and the likely path price should oscillate around--In other words, it should show me where price should run out of up side directional energy and down side directional energy: at the Upper and Lower Median Line Parallels.

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Now here is a simple yet powerful tool from my toolbox and yet, most traders never bother to use it. A wise and very experienced trader once told me that if people would only look at the projection of equal movements, they wouldn't need any other measuring tool when it comes to price projection targets. By this, he meant simply measure how far price moved on one major leg and when the next major leg begins, measure the same amount and expect that price will make it that far--and if you have the right position, take your money and run! Nothing fancy about this, but it is deadly accurate! In simple terms: The distance from A to B will then equal the distance from D to E. Can it go further? Yes. Can it fall short? Yes. But with solid money management, if you capture these equal movements on a regular basis, you will be taking the 'meat' out of a majority of the large moves 80 percent of the time.

Note that price has NOT moved above the Upper Median Line Parallel, so I am still bearish on this market. It would take several closes with quality separation above the Upper Median Line Parallel for me to consider becoming a buyer.

I simply measured the distance from the last high before the vertical drop began to the low made before price began its consolidation [that was 133 pips] and then went over to the last Swing High "C" and projected that same distance below Pivot C to give me the most logical place price would head to with the highest probability. This is a simple but effective tool. Using the simple assumption that the near vertical fall from Swing A to Swing B was 133 pips and moving over to the current high I am assuming is going to develop into Swing High C, I get a potential down side movement to the 136.35 area. Since price is currently trading near what I consider to be overhead resistance at the 137.50 level there is plenty of room below to capture a very significant profit if I can find a repeatable trade entry to establish a short position with good risk reward and solid money management.

Next Week: We’ll look at identifying a repeatable trade entry method with solid money management and good risk reward using tools that are very effective after near vertical falls in stocks, futures and Foreign Exchange in Part II.

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