Theory Of Economic Cycle

Technical Indicators used to determine the trade in our strategy:

• Bollinger Bands Indicator
  
  
• Fibonacci Bollinger Bands Indicator
  Determining Long Term and Short Term Trend
  
  
• Average Directional Movement Index (ADX)
  Determining Strength of Currency Pair
  
  
• Fast Stochastic Oscillator - Short Term Signal
  
  
• Slow Stochastic Oscillator - Long Term Signal

Technical Analysis is a method of evaluating securities by analyzing statistics generated by market activity, such as past prices and volume. Technical analysts do not attempt to measure a security's intrinsic value, but instead use charts and other tools to identify patterns that can suggest future activity.

Technical analysts believe that the historical performance of stocks and forex markets are indications of future performance.

In a shopping mall, a fundamental analyst would go to each store, study the product that was being sold, and then decide whether to buy it or not. By contrast, a technical analyst would sit on a bench in the mall and watch people go into the stores. Disregarding the intrinsic value of the products in the store, the technical analyst's decision would be based on the patterns or activity of people going into each store.

Our TradeVestment strategy focus on technical analysis, once the fundamental of a currency pair is established, technical analysis will determine the entry point, exit point, averaging point of the position, hedging point of the trade or stop loss point.

There are hundreds of technical analysis indicator and tools and every trader uses different tools depending upon their strategy, following are the technical tools used in our Forex Trading Strategy

Bollinger Bands Indicator:

Bollinger Bands was developed by John Bollinger to compare volatility and relative price levels over a selected period of time. You plot the Bollinger Bands (BB) with price. It consists of three bands (moving averages) designed to cover the majority of a security's price action. Those three bands are:

1.In the middle - a simple moving average (SMA) of the closing price;

2.An upper band - an SMA that is in the middle plus n standard deviations (two standard deviations are normally used);

3. A lower band - an SMA that is in the middle minus n standard deviations (two standard deviations are normally used).

The Standard deviation is used to measure a price plot's volatility. Applying the standard deviation to a simple moving average ensures that the upper and lower bands will react quickly to price movements, taking into account periods of high and low volatility. For intermediate time frames, Bollinger advises the use of a 20-bar simple moving average for the center band and two standard deviations for the upper and lower bands. For shorter-term time frames, a 10-bar simple moving average can be used, whereas a 50-day simple moving average is recommended for longer-term time frames

As an example, Bollinger Bands (20, 3, 2) would draw a 20-bar simple moving average, an upper band the same as SMA (20) plus three standard deviations and a lower band as SMA (20) less two standard deviations.

Fibonacci Bollinger Bands Indicator - Determining Long Term and Short Term Trend

The Fibonacci Bollinger Bands indicator is similar to the standard Bollinger Bands indicator, which was developed by John Bollinger. The Fibonacci Bands are based on the same principles as Bollinger Bands by building upper and lower bands on the stock's volatility, but using Wilders Smoothed ATR (Average True Range) instead of using the Standard Deviation.

Like the Bollinger Bands, Fibonacci Bands have a moving average as a middle band. However, Fibonacci bands have three upper and three lower bands in contrast to the Bollinger Bands that has only one upper band and one lower band.

The Fibonacci bands are constructed by multiplying the ATR by each of the Fibonacci factors (1.6180, 2.6180, and 4.2360) and then adding (for upper bands) the results to the middle band and subtracting (for lower bands) the result from the middle band. Overall, the Fibonacci Bollinger Bands Calculation can be separated into five steps:

1.Build a Simple Moving Average (SMA) of the close price as middle band.

2. Calculate the ATR.

3. Construct the first level bands: first upper band by multiplying ATR by 1.618 and adding the result to the middle band and first lower band by subscripting the result of multiplying ATR and 1.618 from the middle band.

4. Construct the second level bands in the same way that the first level bands were build by using the second Fibonacci factor (2.618).

5. The third level bands are made in the same way as the first and second level bands by using the third Fibonacci factor (4.236).

The Average True Range (ATR) is used to measure a price price's volatility. Applying ATR to a simple moving average ensures that the upper and lower bands will react quickly to price movements, taking into account periods of high and low volatility.

Average Directional Movement Index (ADX): Determining Strength of Currency Pair

The Average Directional Movement Index (ADX) is a momentum indicator developed by J. Welles Wilder and described in his book "New Concepts in Technical Trading Systems", written in 1978.
The ADX is constructed from two other Wilders' indicators: the Positive Directional indicator (+DI) and the Negative Directional Indicator (-DI).
The +DI and -DI indicators are commonly referred to as the Directional Movement Index. Combining the +/-DI and applying a Wilders() smoothing filter results in the final ADX value.

Analysis of ADX is a method of evaluating trend and can help traders to choose the strongest trends and also how to let profits run when the trend is strong

An indicator used in technical analysis as an objective value for the strength of trend. ADX is non-directional so it will quantify a trend's strength regardless of whether it is up or down. ADX is usually plotted in a chart window along with two lines known as the DMI (Directional Movement Indicators). ADX is derived from the relationship of the DMI lines.

The ADX's main purpose is to measure the strength of market trends on a 0-100 scale; the higher the ADX value the stronger the trend.
It should be noted that while the direction of price is important to the ADX's calculation, the ADX itself is not a directional indicator.
Values above 40 indicate very strong trending while values below 20 indicate non-trending or ranging market conditions.|
A horizontal reference line is displayed at the +20 level.t

Check out how ADX can be used in Forex Trading Strategy and TradeVestment

Stochastic Oscillator: (Fast/Slow) - Short Term /Long Term Signal

Developed by George C. Lane in the 1950's, the Stochastic Oscillator comes in 3 flavors: Fast, Slow, and Full. Our Forex strategy considers Fast and Slow Stochastic Oscillator.

The Stochastic Oscillator is a momentum indicator designed to show the relation of the current close price relative to the high/low range over a given number of periods using a scale of 0-100.

It is based on the assumption that in a rising market the price(s) will close near the high of the range and in a declining market the price(s) will close near the low of the range.


The Stochastic Oscillator track market momentum and consists of two oscillator lines, called %D is the signal (slow) line and %K. the main (fast)


The Fast Stochastic Oscillator is calculated by the formula:

Fast %K = ((Today's Close - Lowest Low in %K Periods) / (Highest High in %K Periods - Lowest Low in %K Periods)) * 100
%D = 3-period simple moving average of Fast %K

The Slow Stochastic Oscillator is calculated by the formula:

Fast %K = ((Today's Close - Lowest Low in %K Periods) / (Highest High in %K Periods - Lowest Low in %K Periods)) * 100
Slowing %K = 3-period simple moving average of Fast %K
%D = 3-period simple moving average of Slowing %K

There are three basic techniques for using the various Stochastic Oscillators to generate trading signals.

Crossovers:

1) %K line / %D line Crossover: A buy signal occurs When the %K line crosses above the %D line and a sell signal occurs when the %K line crosses below the %D line.

2) %K line / 50-level Crossover: When the %K line crosses above 50 a buy signal is given.
Alternatively, when the %K line crosses below 50 a sell signal is given.

Levels Overbought / Oversold

Oscillator readings below 20% are considered oversold.
Oscillator readings above 80% are considered overbought.
Trades can be generated when the Stochastic Oscillator crosses these levels. A buy signal occurs when the Stochastic Oscillator declines below 20% and then rises above that level. A sell signal occurs when the Stochastic Oscillator rises above 80% and then declines below that level.

Popular trading signals from Stochastic Oscillator

Buy when the Stochastic Oscillator (either %K or %D or %K and %D) falls below the oversold level (e.g., 20) and then rises back above that level.

Sell when the Stochastic Oscillator rises above the overbought level (e.g., 80) and then falls back below that level.

Look for positive and negative divergences between the Stochastic Oscillator and the underlying currency price to predict market reversals.

Trending Versus Ranging Market Signals

In trending markets, take only signals in the main direction of the trend. For an up-trending market, only look for oversold conditions, similarly, for a down- trending market, only look for overbought conditions.

In trending markets

In an up trending market, go LONG if %K or %D falls below the oversold level and then start rising again;

In a down trending market, go SHORT if %K or %D rises above the overbought level and then start falling again.

In ranging markets

Go LONG when %K and %D falls below the oversold level and then start rising back above;

Go SHORT when %K and %D rises above the overbought level and then start falling back below.

Divergence:

Looking for divergences between the Stochastic Oscillator and price can prove to be very effective in identifying potential reversal points in price movement.

Trade long on Classic Bullish Divergence:
Lower lows in price and higher lows in the Stochastic Oscillator.

Trade short on Classic Bearish Divergence:
Higher highs in price and lower highs in the Stochastic Oscillator.

Positive and Negative Divergences between price and Stochastic Oscillator

One of the most reliable signals to use the Stochastic Oscillator is to wait for a positive or negative divergence to develop from overbought(80%) or oversold levels(20%).



Sell Signal (see above example)

Once the Stochastic Oscillator reaches overbought levels, for a SELL signal, simply wait for a negative divergence to develop and then; a cross below the 80% overbought level confirms the negative divergence, a SELL signal is now generated.

Buy Signal

Once the Stochastic Oscillator reaches oversold levels, for a BUY signal, wait for a positive divergence to develop after the Stochastic indicator moves below 20% oversold level; after a positive divergence forms, a break above 20% confirms the divergence and a BUY signal is generated.

Note: It is recommended to use the Stochastic Oscillator in conjunction with other technical analysis tools to make a complete forex trading system.

Check out how Stochastic Oscillator can be used in Forex Trading Strategy and TradeVestment