By Rob Colville on November 25, 2016 in
This is the continuation of our two-part article series, How Strong Is Your Trade Idea? 7 Factors That Can Tell You. Last week, in Part 1, we discussed a trio of (mostly) technically inspired factors including the market’s prevailing trend, the unique reward/risk profile, and the nature of the chart pattern being traded, and explored how each can be used to validate (or even invalidate) a specific trade idea.
While each of the prior factors could be examined using just a current price chart, this week, we’ll profile additional methods for confirming a particular trade idea that may require you going beyond your existing chart. From time-tested indicators, to the higher time frames, and even fundamental and intermarket analysis, these methods are straightforward and reliable, and can add a degree of confidence to any trade idea whenever they act in agreement.
Think about these factors during the analysis process and you may create a more thorough picture of the trade idea in question without creating confusion or blurred signals.
In the name of simplicity and not littering your price chart with multiple indicators, adding in the Relative Strength Index (RSI) to the bottom of the chart can provide a level of perspective you won’t get from looking at price alone. In addition to extreme high (70+) or low (20-) readings in the RSI, which could act as buy or sell signals, respectively, checking for RSI divergence is also a reliable way to validate a particular trade idea.
RSI divergence is present, for example, whenever the asset or currency pair in question is making new highs or lows, but the RSI is not. This might suggest that traders and investors have yet to pile into a momentum move at full force, leaving additional room for said move to continue to either the upside (if bullish divergence) or downside (if bearish).
Yet another simple way to validate the potential strength of a trade idea is to check the 20-, 50-, and 200-period exponential moving averages (EMAs), which can be easily overlaid on any price chart by your trading software. Proper order, angle, and separation between the moving averages suggests the likelihood for continuation of the current trend, which can help validate any trade idea for which the “Trend is your friend.”
Particularly for those who trade predominantly off of daily charts, analysing price action on higher time frames like the weekly and monthly can be quite useful. Often times, a clear and more decisive trend exists on the higher time frames that isn’t as obvious when looking at price action on just the daily or intraday charts. And for long-term traders inclined to stay with their trades for weeks or even months, it seems both proper and justified to understand the behaviour of price on the long-term charts as well.
More than just looking for confirmation signals, though, we’ll sometimes even take trades on the weekly chart if it offers a more favourable entry point or better reward/risk profile than the daily. Regardless, a qualifying chart pattern on the daily time frame, coupled with a clear trend working in its favour on the weekly and/or monthly charts makes for a nice trading opportunity, the kind most traders could take with confidence. So for confirmation, and even for new and perhaps better ways to approach a trade idea, take a moment to “zoom out” and examine the merits and risk factors of the position on the higher time frames.
Even for technical traders, important trade considerations existing beyond the scope of the charts mustn’t go ignored. So once you’ve assessed a trade idea from a technical perspective, it’s wise to also consider the fundamental backdrop impacting the assets or currencies you’re trading, as quite often, there will be both head and tailwinds from such things as geopolitical tensions, central bank monetary policies and interest rates, the economic outlook for the respective nations, and their overall competitive position in the global economy at the time of trading.
Now, rest easier, because a fundamental mastery of the markets and news isn’t required. But for traders with even mainstream knowledge, a look at the fundamentals may yield valuable confirmation when analysing a trade idea, as we received recently when buying SGDJPY.
You see, beyond the chart pattern and technical backdrop, fundamental factors including Japan’s current account deficit, recent comments from US President-elect Trump regarding US/Japanese trade agreements, and the Bank of Japan (BoJ) being handcuffed to ultra-easy monetary policies all suggest a likelihood for continued Japanese yen (JPY) weakness and add a degree of confidence to our trade idea.
I even joked in a recent Market Insider Webinar (subscription required) that “Japan is basically screwed” when it comes to its economic and policy stance, and with so many fundamental factors aligned against the yen, it only helps further validate any technically inspired trade idea that aims to sell JPY versus currency counterparts like the US dollar (USD), Australian dollar (AUD), or as we did recently, the Singapore dollar (SGD).
To truly understand the assets and/or currency pairs you trade, you must also gain an historical perspective as to how said assets and pairs tend to react in response to outside markets or events. Long-standing relationships like seasonal cycles, correlations, and even inverse correlations have been in play for decades or longer in the markets, and can go a long way toward validating a trade idea in any number of assets or currencies.
Think, for example, about the close-knit relationship among commodity currencies like the AUD, Canadian dollar (CAD), and New Zealand dollar (NZD), where price action in the oil and agricultural commodity markets tend to be reflected in some, if not all of these currencies. Also consider gold, the US dollar, and the Swiss franc (CHF) as well-known “safe havens” that tend to see increased inflows during times of volatility in world equity markets. Whenever forex trading switches from “risk-on” to “risk-off,” it’s all the more reason to trust any trade idea that’s built upon buying those safe-haven currencies against riskier counterparts.
And these are only a couple examples of intermarket relationships that are well worth considering whenever analysing a trade idea. So study any and all intermarket relationships for the assets and currency pairs you trade, know how price has tended to react throughout the market’s lengthy history, and always check to see if known intermarket factors are working in your favour whenever you’re weighing the strength of a new trade idea. Alongside the other technical and fundamental factors, this may help build a stronger case either for or against a given position.
Clearly, an entire host of factors—not all of which are technical in nature—can go into every trade decision. So as you continue to develop your own analysis process, follow along with us and receive full access to every video lesson, article, and new trade idea the moment it’s released! All this and more is yours when you join the Lazy Trader community, and you can get started today with a no-risk trial by clicking the banner below.