Long Trades
Turning now to the short side, we look at the daily chart in the EUR/USD trading a relatively small retrace at the beginning of 2006 from 1.2181 to 1.2004. As price once again approaches the 1.2181 level on January 23, 2006, we go short with half of the total position, placing a stop at 1.2358. Prices then verticalize, and at this point the strategy of the setup really comes into play as we short the second half at 1.2278.
Prices push higher, beyond even our second entry, but the move before hitting our stop. We exit half of the trade as prices come back to 1.2181 and move our stop to breakeven on the whole position. Prices then proceed to collapse even further as we cover the second half at 1.2092, banking the full profit on the trade.
|
|
| Figure 4: The memory of price, EUR/USD |
| Source: FXtrek Intellichart |
In another short example of this setup, we look at the hourly chart in the USD/JPY as it forms a retrace between 8 a.m. EST March 29, 2006, and 8 a.m. EST March 30, 2006. The amplitude of that range is 118.22 to 117.08, or 116 points. We then add 116 points to the swing high of 118.22 to establish our ultimate stop of 119.36. As it trades back up to 118.22 on April 3, 2006, we short half of our position size and then short the rest of the position at 118.78. Prices do not trade much higher and by 10 a.m. EST the next day we are able to cover half of our short at 118.22. Just 10 hours later, at 8 p.m. EST, we are able to close out the rest of the position for profit.
|
|
| Figure 5: The memory of price, USD/JPY |
| Source: FXtrek Intellichart |
This example illustrates once again the power of this setup on the shorter time frames. The small risk parameters and the relatively short time frames allow nimble forex traders to take advantage of the natural daily ebb and flow of the markets. Clearly this setup works best in range-bound markets, which occurs a majority of the time.
When This Trade Fails
The gravest danger to the memory of price setup is a one-way market during which prices do not retrace. This is why keeping disciplined stops is so essential to the strategy because one runaway trade could blow up the trader's entire portfolio.
|
|
| Figure 6: The memory of price, USD/JPY |
| Source: FXtrek Intellichart |
In the preceding example, we see how the daily trend on the USD/JPY pair during the fourth quarter of 2006 reached such powerful momentum that traders had no chance to recoup their losses, and shorts were simply steamrolled. Starting with the initial entry on September 20, 2005, off the countertrend move at 111.78, we proceeded to short the pair at half position value, adding yet another half position seven days later on September 27, 2005, at 113.33. Unfortunately, prices did not pause in their ascent, and the whole trade was stopped out at 114.88 on October 13, 2005, for a total loss of 465 points ((114.88-111.78) + (114.88-113.33) = 465).
END
