How to Trade with DMI
The EURGBP has recently tested resistance after a 250 pip advance. As the pair stalls traders can turn to DMI to find the prevailing trend.
The primary objective of a Forex trader is to find market direction. There are a variety of methods for finding the trend however interpreting price action can often be difficult and sometimes misleading. To help ease in this process traders often will employ the use of technical indicators.
In todays example we will be looking at the EURGBP daily chart pictured below. The pair has advanced as much as 394 pips from its July 23 low. However, resistance has been met near its October high at .8164. So what is a trader to do in present markets? Which direction is the EURGBP trending? To answer these questions, we will tae a closer look at the DMI indicator.
Learn Forex – EURGBP Daily Trend
The DMI indicator is derived from two lines, the positive directional movement indicator (DMI+) and the negative directional movement indicator (DMI-). Both lines run in a range between 0-100 to help identify if a currency pair is trending up or down. The DMI + line is depicted as a green line and as its name suggests helps track price in an uptrend. The DMI - line is depicted as a red line and measures the strength of a downtrend. Traders will watch both lines as they oscillate between 0-100 and change their market preference as one line crosses above the other.
Reading DMI is relatively straightforward. Traders will look for the DMI line that is moving higher than the other. This is also known as the dominant DMI line. In the chart below, DMI + has crossed above DMI - , making it the dominant DMI line and suggesting that the trend is up. If DMI – was the dominant line the opposite would be true. Traders would then conclude that the market was intending to move lower.
Learn Forex – EURGBP with DMI
Using DMI my preference is to look for continued strength on the EURGBP. This will continue as long as DMI + remains above DMI -. One way to trade this market bias is to look for breakouts toward higher highs. If DMI + increases in value, traders may look to employ a trending strategy as
An alternate scenario includes price moving to higher highs. If this occurs traders will be notified as the DMI - line will cross back above DMI +.
While I occasionally trade from the Daily chart, primarily I use it to determine the trend of the pair.Once I have identified the pair that I feel has the strongest trend based on the Daily chart, I will usually enter on a 4 hour or 1 hour chart...whichever time frame best optimizes my entry.Here's what I am looking for chart by chart...The Daily Chart: The Daily Trend on the NZDJPY is down. This determination is made based on the pair making lower highs and lower lows, price action is below the 200 SMA and pulling away from it and, at the time of the analysis, the NZD was the weakest currency and the JPY was the strongest. Also, looking at Slow Stochastics, I see that it is below 20 which is a very bearish sign.Given all of the above, I know I will only be looking for opportunities to sell the pair as they will have the greater likelihood of success. (Trading in the direction of the longer term trend offers us that edge.)The 4 Hour Chart: Then I will look to the 4 hour chart and look for a retracement (a move against the Daily trend) to be finishing and beginning a new move to the downside. In other words, a fresh move back in the direction of the Daily trend. Sometimes that fresh move will present itself straightaway or I may have to wait for the set up to occur.In the case of this particular 4 hour chart I would need to wait for the pair to cycle back up as a new move to the downside has already taken place over the last five red candles on the far right of the chart.I will also run through this same process on the one hour chart looking for the same set up.Once a“fresh move” begins on either the 4 hour or the 1 hour chart, an entry can be made with a stop placed above the highest level of the recent retracement. (Stochastics, MACD or RSI can be used to further time the entry.)The 1 Hour Chart: In the case of this 1 hour chart, I would be waiting for a pullback/retracement to take place to short the pair.Since the pair has been in a strong, on-going downtrend on the Daily chart, I would have been able to successfully sell the pair at any of the points on the chart after the retracement (black arrows) takes place. The short position would be opened when momentum shifts back to the downside (Stochastics crossover within the black circles). In each instance the stop would go above the most recent high approximately at the black lines.Sidebar: Some traders will become frustrated when they see price is moving opposite the direction of the Daily trend. Don’t worry about it. It is fine since that means a retracement is taking place and once that is complete, we will be looking at an opportunity to enter the trade in our direction of choice...the direction of the Daily trend.
One of the toughest tasks given to traders is spotting price reversals. There are a variety of tools at the disposal of technical Forex traders for the job, but more often than not it is a candlestick pattern that provides the first clues to a market turn. Candlestick patterns are a great way to begin your trading analysis as they are a direct interpretation of price action. With this in mind, today we will focus on spotting and trading one of the markets most clear cut reversal signals using the bullish morning star pattern. What is a bullish morning star pattern?A bullishmorning star pattern is a candle pattern established at the end of an extended downtrend. The pattern itself is pictured above,and it should be noted that the bullish morning star is comprised of three different candles. The first candle should depict a continuation of the established down trend. The second candle will show the slowing of bearish momentum. Price will make one final attempt at lower lows here, with the candle closing near its open price. Dojis and hammer candles are often found in this position.The third candle in the bullish morning star pattern is the actual reversal signal. An extended blue candle should be seen in this position beginning a new swing in bullish momentum. Ideally this should be a bullish engulfing candle with its high extend well above the high of the previouscandle. This strong surge in price depicts fresh buying pressure on the pair with bearish traders exiting the market. The greater the advance of this secondary candle declines, the stronger the reversal signal is considered. Uses in TradingThe great thing about the bullish morning star pattern is the fact that once you can identify it, you can immediately apply it to your trading. In the graph above we can see the pattern in action on a GBPNZD daily chart. From April 13th through May 24th of this year the GBPNZD rallied as much as 1883 pips. This rally was preceded with a bullish morning star giving us our first opportunity to consider trading a reversal and establishing buying opportunities.Traders often select to trade a breakout strategy in reversing markets. In a breakout scenario the high of the first candle of the pattern can be used as an area of resistance. Entry orders to buy can be set at this point as the pair begins to trade to higher highs. Also it is not uncommon to see traders use this analysis in conjuncture with an oscillator. Market orders can be placed in the direction of the new trend when indicators such as RSI show momentum returning from oversold levels. Regardless of the method chosen, traders should consider placing a stop order under the second candle low. In the event that a reversal fails and a lower low is made traders will want to exit their buy positions.
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