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Jay Norris
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Jay Norris is a 20-year CBOT floor veteran, author of the Best Seller "The Secret to Trading Forex, Futures, and ETFs: Risk Tolerance Threshold Theory", "Mastering the Currency Market", McGraw-Hill, 2009, and "Mastering Trade Selection and Management", McGraw-Hill,... More
My company:
Trading University
My blog:
Seeking Alpha
My book:
The Secret to Trading Forex, Futures, and ETF's: Risk Tolerance Threshold
  • Lower Volatility = Lower Time Frame Charts = More Stable Trading Metrics  0 comments
    Feb 21, 2014 12:56 PM | about stocks: FXE

    Most traders today don't need to see headlines like: "Currency Traders' Strategies Foiled as Trends Go Missing" to know that volatility in the financial markets has been moving lower for some time. For day traders this is a good thing because shrinking volatility, i.e.: smaller trading ranges, lowers risk.

    In our studies we also see that even though volume is dropping, and thus volatility is falling, market behavior, as measured by the ratios of both the impulse and corrective waves, has not changed. If the actual ratios of market moves are unchanged, then the risk-reward-ratios and winning percentage for a method based on pattern recognition will remain the same.

    The evolvement towards smaller market ranges in recent years has not meant a change in the patterns market behavior creates, but it has made a major change in the behavior of traders. Many retail traders are learning what professional traders have known for years, lower time frame charts decrease risk but not reward.

    (click to enlarge)
    Figure 1. 40-tick Euro Futures Chart

    The chart in Figure 1 - Euro futures on 2-21-14 -- illustrates the advantage of lower time frame charts. This chart is a tick chart. It is not based on time, but on how often a market trades. Once price changes 40 times the candle advances. On average it moves much faster than even a 1-minute chart. The method illustrated here is simple. We place a retracement tool on the chart which marks the 50% retracement level in purple, the .625 retracement level in green, and the 75% retracement level in red. The idea is to find a micro up-move in a market displaying a collective bullish pattern - as the Euro was on this day -- and wait for that market to correct into the buy zone created by the purple and green lines. The buy signal itself is a shift of momentum higher - see green circle -- and the stop is placed a tick below the red line. The profit target is 1.4 times the risk - see red circle. Here the trader bought Euro futures at 137.11 and exited the trade at 137.18. The risk was 5 ticks - $31.25 per mini future, or $62.5 per standard; and the reward was $43.75 per mini future or $87.50 per standard (commission + fees = approx. $4.50.) The trader was in the trade for approximately 20 minutes.

    The tactic used in this trade is nothing new. Looking for a market to stabilize in the zone created by the 50% and .625 retracement levels was first taught by W.D. Gann over 75 years ago. Gann referred to .625 retracement level on the chart as "the bottom of the pipe" in a bull move (or "top of the pipe" in a bear move). The point being that focusing on a .625 retracement in an up-move for a buy signal is by no means a new development for experienced traders.

    I can tell you from our own studies at Trading University over the last 6 years that despite the varying degrees of the height and length of market moves, the one thing that remains constant through the seasons and over the years is the ratios of the retracements and extensions of those moves. The nature of market movement remains unchanged.

    Traders however must make the choice of scrolling down to lower time frame charts to take advantage of the detail of micro price action which does not show up on standard time based charts. Figure 2 is a 3-minute Forex chart of the same time period covered in the 40 tick futures chart, and you can see how this chart lacks that tradable detail. Also by waiting for a signal on this 3-minute chart our risk increases as our entry comes later so we need to place our stop further from that entry.

    (click to enlarge)
    Figure 2. 3-minute Euro Forex Chart

    The trepidation many retail traders have over lower time frame charts is understandable. If you are already uncertain over aspects of what you are doing, which is common for traders in their first few years, and you are asked to introduce a new wrinkle on top of already unstable base, you are likely to hesitate. What makes sense about scaling down the time frames you trade is the knowledge that markets are scalable. The proof of this can be seen on any time frame chart any day of the week in the form of those constant ratios created by market retracements.

    The most important aspect of trading is the ability to glean the statistics of your method over time so that you can develop that assurance that what you are doing is worth your time and eventually your risk capital. Lower time frame charts can offer you a lower risk per trade which is a step toward more stable trading metrics and a more manageable learning curve.

    To see Jay Norris highlight trade set-ups and signals in live markets during the London/U.S. overlap go to: Live Market Exercise. Jay is the author of "The Secret to Trading: Risk Tolerance Threshold Theory".

    Trading involves risk of loss and is not suitable for all investors.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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