This simple trading strategy, only has a few easy to understand rules - there easy to apply and profit with so let's take a look at them.
Look for a Currency Pair in the News with High Speculative Interest
When prices are trading beneath resistance, you can scan the news for a currency pair which the news is focused on and calling the resistance level “critical” or “likely to break”. You won't be the only trader watching this level, other traders will watching it to but you will look to fade the breakout not go with it. So how do you know, if you should fade a move to resistance and a break above it?
Look for an Overbought Currency Close to Breakout
The key is to watch momentum below the level – if its reading is overbought, then you will assume that there will not be enough buying to take the currency above the level of resistance you are watching. You can use any indicator you like but my favourite is a fast stochastic set at 14:3, although sometimes I will use a slow stochastic which is less sensitive and therefore an overbought reading is more valid. It doesn’t matter which momentum indicator you use, you simply want it to be registering overbought as it comes into test the level in terms of your trading method.
Bulls and Bears and the Fight at Resistance – No Winners only Losers
If there is high interest in the pair and the level is seen as critical, prices will move up to the level and will probably trade through it. The logic behind this is simple:
Most traders are looking to trade the breakout as soon as it occurs from the long side but another huge group, are “top pickers” and will want to hit the move into resistance. When the breakout occurs the bearish traders fight the bullish traders but prices don't stay on one side for long and this is based on bulls and bears cancelling each other out.
Prices will trade above the level of resistance, as traders buy the breakout and be hit by bearish traders who come in from the short side. In terms of most breakouts from overbought levels, the bulls will be able to push the price through the level and force the bears to cover stops which are tight behind the level of resistance that has given way. The bulls however may look like they have defeated the bear traders but they haven't. This is because, there will not be enough of them to hold the price above the breakout, prices will come back and then take out their stops.
If you keep in mind, most traders are short term and want to trade the level, you will see why this battle occurs and why most traders lose. The bears get hit on stop on the poke above resistance, while the bulls get in on the break and then are pushed back to their stops.These traders are trading to short term, on a level and with to tight a stop and are normally greedy or inexperienced retail traders.
Trading False Breakouts
Wait for the breakout to occur and Simply look for momentum to turn down and take prices back below the breakout point – then sell and put your stop loss behind the high made on the initial break. You can do this in the day session or do it at the close and my own view is – when a currency is severely overbought, I would do it in the day session and if I am less certain I would wait for the close of business and see if prices are back below resistance and sell.
The trap most traders fall into when keying off an important resistance level, either from a bullish or bearish point of view is being to eager to put their trading signal in the market and also, placing their stop, where the market is likely to take it out. We all have the same resistance and support levels to look at when using technical analysis and currency charts and a huge amount of volatility occurs around these levels as a result. The bulk of traders see the levels as important to quickly and lose; the smart trader waits for the majority to get hit on stop and then enters the market, after the dust has settled. Sounds like a simple trading strategy for profit?– it is.
The key to making it work is to make sure that momentum is very overbought when coming into the level being tested in a bullish currency or at a bearish extreme when trading the short side. You want to make sure that the market doesn't have enough buyers or sellers, to take out the breakout point and hold above or below it.
If you think about the above trading strategy, you can understand the logic behind it and use it to execute trading signals, against support and resistance levels, in a way that most currency traders don't consider. We all have the same chart formations to look at but the key to enjoying currency trading success is to use them in a different way, to the majority of traders who lose money. If you practice the above trading method, you will soon see how effective it is at generating, some treat low risk trading signals for big profits.