Strategy trading double zero




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Strategy trading double zeroFading The Double Zeros

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One of the most widely overlooked yet lucrative areas of trading is market structure. Developing a keen understanding of micro structure and dynam­ics allows traders to gain an unbelievable advantage and is probably one of the most reliable tactic for profiting from intraday fluctuations. Developing a feel for and understanding of market dynamics is key to profitably taking advantage of short-term fluctuations. In foreign exchange trading this is especially critical as the primary influence of intraday price action is order flow. Given the fact that most individual traders are not privy to sell-side bank order flow, day traders looking to profit from short-term fluctuations need to learn how to identify and anticipate price zones where large order flows should be triggered. This technique is very efficient for intraday traders as it allows them to get on the same side as the market maker.

When trading intraday, it is impossible to look for bounces off of every support or resistance level and expect to be profitable. The key to successful intraday trading requires that we be more selective and enter only at those levels where a reaction is more likely. Trading off psycholog­ically important levels such as the double zeros or round numbers is one good way of identifying such opportunities. Double zeros represent num­bers where the last two digits are zeros—for example, 107.00 in the USD/JPY or 1.2800 in the EUR/USD. After noticing how many times a cur­rency pair would bounce off of double zero support or resistance levels intraday despite the underlying trend, we have noticed that the bounces are usually much bigger and more relevant than rallies off other areas. This type of reaction is perfect for intraday FX traders as it gives them the opportunity to make 50 pips while risking only 15 to 20 pips.

Implementing this methodology is not difficult, but it does require in­dividual traders to develop a solid feel for dealing room and market participant psychology. The idea behind why this methodology works is simple. Large banks with access to conditional order flow have a very dis­tinct advantage over other market participants. The banks' order books give them direct insight into potential reactions at different price levels. Dealers will often use this strategic information themselves to put on short-term positions for their own accounts.

Market participants as a whole tend to put conditional orders near or around the same levels. While stop-loss orders are usually placed just beyond the round numbers, traders will cluster their lake-profit orders at the round number. The reason why this occurs is because traders are humans and humans tend to think in round numbers. As a result, take-profit orders have a very high tendency of being placed at the double zero level. Since the FX market is a nonstop continuous market, specula­tors also use stop and limit orders much more frequently than in other markets. Large banks with access to conditional order flow, like stops and limits, actively seek to exploit these clustering of positions to basi­cally gun stops. The strategy of fading the double zeros attempts to put traders on the same side as market makers and basically positions traders for a quick contra-trend move at the double zero level.

This trade is most profitable when there are other technical indicators that confirm the significance or the double zero level.

Strategy Rules

• First, locate a currency pair that is trading well below its intraday 20-period simple moving average on a 10- or 15-minute chart.

• Next, enter a long position several pips below the figure (no more than 10).

• Place an initial protective stop no more than 20 pips below the entry price.

• When the position is profitable by double the amount that you risked, close half of the position and move your stop on the remaining por­tion of the trade to breakeven. Trail your stop as the price moves in your favor.

• First, locate a currency pair that is trading well above its intraday 20-period simple moving average on a 10- or 15-minute chart.

• Next, short the currency pair several pips above the figure (no more than 10).

• Place an initial protective stop no more than 20 pips above the entry price.

• When the position is profitable by double the amount that you risked, close half of the position and move your stop on the remaining por­tion of the trade to breakeven. Trail your stop as the price moves in your favor.

Market Conditions

This strategy works best when the move happens without any major eco­nomic number as a catalyst in other words, in quieter market conditions. It is used most successfully for pairs with tighter trading ranges, crosses, and commodity currencies. This strategy does work for the majors but un­der quieter market conditions since the stops are relatively tight.

Further Optimization

The psychologically important round number levels have even greater sig­nificance if they coincide with a key technical level. Therefore the strategy tends to have an even higher probability of success when other important support or resistance levels converge at the figure, such as moving aver­ages, key Fibonacci levels, and Bollinger bands, just to name a few.

So let us take a look at some of the examples of this strategy in action. The first example that we will go over is Figure 8.8, a 15-minute chart of the EUR/USD. According to the rules of the strategy, we see that the EUR/USD broke down and was trading well below its 20-period moving average. Prices continued to trend lower, moving toward 1.2800, which is our double zero number. In accordance with the rules, we place an entry order a few pips below the breakeven number at 1.2795. Our order is trig­gered and we put our stop 20 pips away at 1.2775. The currency pair hits a low of 1.2786 before moving higher. We then sell half of the position when the currency pair rallies by double the amount that we risked at 1.2835. The stop on the remaining half of the position is then moved to breakeven at 1.2795. We proceed to trail the stop. The trailing stop can be done using a variety of methods including a monetary or percentage basis. We choose to trail the stop by a two-bar low for a really short-term trade and end up getting out of the other half of the position at 1.2831. Therefore on this trade we earned 40 pips on the first position and 36 pips on the second position.

Figure 8.8 EUR/USD Double Zeros Example

( Source: eSignal. eSignal)

The next example is for USD/JPY. In Figure 8.9, we see that USD/JPY is trading well below its 20-period moving average on a 15-minute chart and is headed toward the 105 double zero level. This trade is particularly strong because the 105 level is very important in USD/JPY. Not only is it a psychologically important level, but it also served as an important support and resistance level throughout 2004 and into early 2005. The 105 level is also the 23.6 percent Fibonacci retracement of the May 14, 2004. high and January 17, 2005. low. All of this provides a strong signal that lots of spec­ulators may have taken profit orders al that level and that a contra-trend trade is very likely. As a result, we place our limit order a few pips below 105.00 at 104.95. The trade is triggered and we place our stop at 104.75. The currency pair hits a low of 104.88 before moving higher. We then sell half of our position when the currency pair rallies by double the amount that we risked at 105.35. The stop on the remaining half of the position is then moved to breakeven at 104.95. We proceed to trail the stop by a five-bar low to filler our noise on the shorter time frame. We end up selling the other half of the position at 103.71. As a result on this trade, we earned 40 pips on the first position and 76 pips on the second position. The reason why this second trade was more profitable than the one in the first exam­ple is because the double zero level was also a significant technical level.

Figure 8.9 USD/JPY Double Zeros Example

( Source: eSignal. eSignal)

Figure 8.10 USD/CAD Double Zeros Example

( Source: eSignal. eSignal)

Making sure that the double zero level is a significant level is a key el­ement of filtering for good trades. The next example, shown in Figure 8.10, is USD/CAD on a 15-minute chart. The great thing about this trade is that it is a triple zero level rather than just a double zero level. Triple zero levels hold even more significance than double zero levels because of their less frequent occurrence. In Figure 8.10, we see that USD/CAD is also trading well below its 20-period moving average and heading toward 1.2000. We look to go long a few pips below the double zero level at 1.1995. We place our stop 20 pips away at 1.1975. The currency pair hits a low of 1.1980 before moving higher. We then sell half of our position when the currency pair rallies by double the amount that we risked at 1.2035. The stop on the remaining half of the position is then moved to breakeven at 1.1995. We proceed to trail the stop once again by the two-bar low and end up exiting the second half of the position at 1.2081. As a result we earned 40 pips on the first position and 86 pips on the second position. Once again, this trade worked particularly well because 1.2000 was a triple zero level.

Although the examples covered in this chapter are all to the long side, the strategy also works to the short side.

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