Lessons from the Pros

I realize that foreign exchange trading, or Forex, is a brave new world for many traders out there. As someone who has successfully made the switch from equities to Forex, I’m happy to explain the similarities and the differences between these two trading vehicles, and hopefully shine a light on some of the advantages of Forex. I firmly believe that if more traders were aware of these advantages, many of them would switch to currency trading in a heartbeat. Let’s get to your questions…

Q) Regarding the times of days when breakouts are likely to be supported by volume, would any time from 7 a.m. GMT to 4 p.m. GMT be a good assumption for high-volume trading?

Ed Ponsi) What a great question! Many equities traders use volume as an indicator, and give more credence to moves that occur on high volume. Since the Forex market is much larger than any stock market, this makes the collection of accurate volume data extremely difficult. How can Forex traders apply this philosophy of volume to their market? We do so by paying close attention to the time of day.

7 a.m. GMT to 4 p.m. GMT (Greenwich Mean Time, which is the standard measurement of time in the Forex market) is an excellent time for high volume trading, because these are the hours during which traders from London and Europe are most active. Make no mistake about it, London is the world’s capital of Forex trading, and is responsible for about 30% of all Forex volume. To be even more specific, the open of the U.K. session (between 3-5 GMT a.m.) and the beginning of the US session (11-13 GMT) have really high volume, as these are the most liquid times of the Forex trading day. I would give respect to breakouts that occur between 7 a.m. GMT to 4 p.m. GMT, and also (to a lesser extent) to breakouts that occur in the early part of the Asian session, around midnight GMT. On the other hand, breakouts that occur during a time of day that is notorious for low volume (late in the U.S. session or late in the Asian session, for example) can be ignored or even faded, because these breakouts tend to occur on relatively light volume.

Figure 1: On the weekly chart, USD/CAD encounters resistance at the 50% retracement of a major move. Source: Saxo Bank.

Q) Regarding Fibonacci retracements, I notice that in your writings 78.6% and 23.6% are not mentioned. Is there any special reason why you focus on the 38.2%, 50%, and 61.8% Fibonacci retracements?

E.P.) I purposely omit what I consider to be all but the most significant Fibonacci levels from my analysis. Fibonacci is a self-fulfilling prophecy, so the most obvious levels will see the most action. I tend to avoid the less-obvious levels, along with Fibonacci extensions, Fibonacci circles, and other esoteric Fibonacci derivatives because fewer people use them and therefore there is less of a chance for the creation of a self-fulfilling prophecy. Basically, I want to use what the institutions use and see what they see, and I want to avoid analyzing anything that institutions do not use. Since institutional traders are the ones that move the market, we want to align our analysis with theirs. We want to see what they see, and ignore what they ignore (see figure 2).

Q) I sometimes struggle to know where it is best to measure Fibonacci retracements from – is it the last major move or from the very bottom of the original trend?

E.P.) This is the most common Fib question – A good general rule of thumb is to draw from a major high point to a major low point, if you are measuring a downtrend. When measuring an uptrend, reverse the process and measure from a major low point to a major high point. Use the highest and lowest price points of a recent move or leg of a trend. You can also draw from the very beginning of a trend as well. Don’t be afraid to draw more than one; the fact is you can draw multiple Fib levels on the same chart. Many Fib traders do exactly this, and then look for areas where the Fib retracements converge.

For me, the bare minimum time frame for a Fibonacci retracement would be one day, but when I draw a retracement usually I am covering a period of weeks or months. Again, try to pick the one that seems most obvious…which one really sticks out? That’s the one that most people will use, including the institutions and hedge funds, and therefore it is the one that is most likely to work.

Until next time, best of luck to you in trading!

If you have questions for Ed Ponsi about Forex trading, please send them to eponsi@tradingacademy.com