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British Pound - How To Cover A Short Position In ANY Market - The Market Is THE Superior Source Of Information

Monday 21 December 2009

We recently recommended short positions at 163.50,
British Pound - Trouble Across the Pond. One thing no one can ever know is the outcome for any given trade. Developing market
activity will provide the answer, as new price information becomes
available.

Where can this market go? It could very well retest the 140 area,
but if it does, it will not happen in a straight line down.

As an aside, if anyone ever tells you that technical analysis is useless, you can rest assured that person is incompetent/ignorant in the art of it. This British Pound trade is a perfect illustration of how the proper application of a chart(s) analysis draws from the best
available source of reliable information, the market itself. You will
never see us use RSI, [Relative Strength Index], MACD, Bollinger
Bands, moving averages, et al. They are a past tense effort to
capture and define future market behavior.

The very notion is capturing and defining the future is absurd in
itself. We are always willing to acknowledge that a stopped clock is right twice a day, and with consistency. The same cannot be said
for mechanical tools, but people want a holy grail, so the popularity
of these applications will continue to have a following.

Back to our notion of reality. Let us point out that most of the
lines drawn on our charts are a priori to future events. The daily
British Pound charts will illustrate this clearly.

Markets are dynamic and ever-changing. Be confident in knowing
that there are no cookie-cutter forms to apply for any market.
There are tools that do come in handy, but just as you cannot use
a wrench when a hammer is needed, one has to have an
understanding of how markets work in order to know what to use
and when. Our tools are price, volume, lines to denote support or
resistance, and experience.

On the first chart, a gap is shown on the current Mar contract,
when Dec was the lead month at the time. We also will deal with
the application and use of trend channel lines. Let's start with the
gap.

A gap is formed [a space between the high of a bar and the higher
low of the next bar, or the low of a bar and a lower high on the next
bar, in a down market] when there is a sudden demand as buyers
enter the market in an overwhelming capacity that drives price
higher. What we know about such areas of demonstrated strength
is that they will be defended. This gap was formed in mid-October and becomes a potential source of information. We can expect the 160 -160.90 area to be defended sometime in the future.

Next is the trend channel. It requires three points, a high, A, a
low, B, and a lower high, C, [the reverse in a up trend]. A straight
line is drawn, connecting the two highs and extending into the
future, as a broken line. From point B, a parallel line is drawn into
the future, called a Reverse Trend Line, [RTL]. All we need are
these three pieces of market information to create the channel
lines.

Why draw these lines?

The top line functions as potential resistance for rallies. The
bottom line serves as an oversold indicator, and it may act as
support. Understand that these line are just guides and not
absolute points from which to take immediate action to buy or sell.
At times, they can work quite well. What is more important is to
watch HOW price reacts to them. It is the REACTION that conveys
a market message.

Fast forward to Friday 18 December and the second chart.

BPH D 21 Dec 09

We are getting some valuable pieces of market information. Rally
bar D tells us that the attempt to get back to the upper channel
failed to make it beyond half way in the channel. When a rally fails
to recover to a half-way retracement, it tells us the market is
weak. Bar D tried to go higher, but in the attempt, there were no
willing buyers to support the rally, and we know this by the position
of the close. It is about mid-range, indicating that sellers were
present on the top half...what one would expect in a weak market.

The next bar, second from the end, broke hard with ease of
movement down. This is where we went short at 163.50,
[British Pound - Trouble Across the Pond, mentioned above]. The
low of that bar touches the RTL, alerting us to the Pound being in
an oversold condition. Remember, this line is just information, a
guide, a red flag to pay closer attention to market activity. Price
can STAY in an oversold condition, and it can become MORE
OVERSOLD by trading under the RTL, as happens. This is why we
said to watch HOW price REACTS to these areas and not to use
them as absolute trading points, as many who misunderstand
technical analysis do.

Volume does increase, and the close is off the low so we know
there was some buying, most likely short-covering and not new long positions from strong hands.

As a reminder, there was that gap which formed back in mid-
October, and we said the information it gave us was to expect the
160 -160.90 area to be defended because it is here that new buying came in, at that time. You can see that the RTL also goes through
the same price area. One indicator can be good; two or more
separate indicators converging is even better. There are no
accidents, so take note.

BPH D2 21 Dec 09

The third chart is a 240 minute chart, [4 hours], used by
professional Forex traders, including us. Now we are getting into
greater detail because of the convergences, [alerts], just
mentioned. The last wide range bar down from 162.50 to 160.43
touches the RTL, is in the gap area, and it has high volume. The
increased volume is third piece of important market information.
To repeat, high volume bars often denote a transfer of risk from
strong to weak hands.

We drew a horizontal line from the bottom of the bar D, just in case it gets retested. If it does, we want to see HOW the market
responds to it, after the rally from that low. Two trading days later, we get an answer. There is a retest. It becomes a probe lower,
looking to see if there are any more sell-stops under the market.
The high volume tells us a lot of sell-stops were triggered, [smart
money covering while weak players who have missed the sell-off and
want in before they miss anymore, sell down here. Some things
never change.]

The failed probe lower on high volume, at the gap support and RTL
areas is the market's message that shorts are being covered. We
were one of them, at 160.75, for a 275 pip gain. We had already
taken partial profits on half positions at 160.90, for a 260 pip gain,
on the first decline to the RTL, just to reduce risk exposure by
locking in some profits.

BPH 240m 21 Dec 09

The last chart is a 60 minute chart that amply illustrates the
market activity we have been describing. Art work is always
helpful. Look at the large bar down, 6th from the end, and note the volume. The clincher is the next bar, 5th from the end. It has
equal volume to the previous sell-off bar, but this one is much
smaller. Why is it smaller? Because buyers, [those covering
shorts] were in the market in a big way at support, [as we have
defined it], and the buying activity was much greater than the
selling activity which kept the bar from extending lower. Those two
bars were the culmination to the selling effort down from the 164.00 failed rally high, two days earlier.

This is how one reads market activity, and it shows how the market
acts as a reliable guide. Not a bad trade, but we cannot take a lot
of credit because we missed the sell from the 165 and higher level,
after price failed at 167 on 3 December. Not all market reads are
this "easy," but when we can harmonize with the present tense
developing market activity, risks are less and profit potential is
greater.

Now you can see why anyone who says technical analysis does not
work simply does not know HOW it works. On to the next trade.
May it be as clear and as profitable as this one. In fact, the next
trade may soon be in the British Pound, for this market is still going lower.

We have a free two week trial subscription for those interested. Visit http://www.edgetraderplus.com/, and click on the link half way down the page.

Cheers!

BPH 60m 21 Dec 09