Course Guide Harmonic
Course Guide Harmonic
Course Guide Harmonic
contents
1.1
This section will introduce Derek Frey and his trading background.
1.2
This section will focus on the critical components required to develop a high probability
trading system.
1.3
This section covers the development of a master trading plan and the importance of
using the plan consistently and the proper use of leverage and risk management
This section explores the habits of human behavior which form patterns that can be
2.2
2.3
This section focuses on important Fibonacci ratios and how they apply to harmonic
trading.
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2.4
This section introduces the Gartley Pattern which is the basis of all harmonic trading and
This section introduces other harmonic patterns which are variations of the Gartley
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pattern.
3.2
This section introduces the Bear and Bull Butterfly Gartley Patterns.
3.3
This section introduces the Bear and Bull Crab Gartley Patterns.
3.4
This section introduces the Bear and Bull Bat Gartley Patterns.
3.5
This section looks at how the other harmonic patterns are identified by Elemental Trader
This section provides a step by step walk through of the installation process of the
4.2
This section explores recognizing and interpreting the harmonic patterns on trading
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4.3
This section discusses how to use the Elemental Trader software to determine Risk and
Reward for the patterns that are presented, how to use a scale in approach to
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5.1
This section explores the importance of a personal trading plan and how it can reduce
trading based on emotion whilst assisting in measuring progress towards trading goals.
5.2
This section focuses on the specific topics which need to be included in a personal
trading plan.
5.3
In this section, the importance of applying a personal trading plan in all trade
considerations is discussed.
This section addresses the importance of looking at Forex trading as a business when
6.2
Account Capitalization
6.3
This section focuses on the development of proper leverage and risk guidelines to help
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Introduction
introduction
The purpose of this course is to introduce concepts specific to the method of harmonic trading.
The course is made up of six modules and these modules will start by introducing the
foundations of harmonic trading concepts and will build from there until harmonic trading
patterns are understood and can be applied and a personal trading plan developed.
It is important to start from the beginning of the course, as by skipping ahead, critical
components of the system may be missed. A good analogy to this is building a wall, if bricks are
missed out at the bottom of the wall, it will eventually fall down.
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Therefore, the course should be followed progressively. Avoid jumping ahead and implementing
a trading plan without first understanding the methodology behind the trading plan. If the time
necessary to learn the methodology is not invested, the chance of trading success is reduced.
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Module 1 Introduction
and Harmonic Trading
Method Overview
Introduction to Module 1
This module introduces, and provides an overview, of a method of harmonic trading.
The objectives for this module are:
to look at the components that are essential to developing a winning trading system; and
to look at measures which can be taken, by developing a personal master trading plan, that
will help ensure consistent trading results.
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1.1 Introduction to Derek Frey
Derek Frey has been a full time trader since 1989. Derek started in the Futures and Options
markets and as he gained experience be became a Futures and Options broker. In 2003, he
started his own Futures and Options and Forex firm which he sold in 2008.
Derek has become renowned for his knowledge and, throughout his career; he has been
sought after as a key market commentator. He is a weekly guest on Forex TV and has often
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been quoted by many well known financial publications including the Wall Street Journal
and The Economist. In addition, Derek was the Keynote Speaker at the International Traders
Conference in Barcelona, Spain in 2008.
For the past few years Derek has put much of his focus in the currency market and Forex
trading. Derek has also been a chief contributor and a vital resource to the development of the
Elemental Trader course which is based on a Harmonic trading Method on which he focuses.
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Following these procedures will lead to specific decision points where decisions must be made
before a trade is entered. These decision points will arise in response to predetermined criteria
and will lead to a specific action to be taken. In this case, the action will be to trade or not to
trade, which means they are effectively go or no-go decision points.
Before a trade is entered, all the criteria for set up, that adhere to some sort of trading
methodology or system, should have been met. The trading system should also have
predetermined limits for risk and evaluate the risk to reward ratios for each individual trade
scenario and again these should always be respected in making the decision to trade.
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If the set-up criteria are satisfactorily met then the next step should be considered.
3. Determine Potential Risk
Before entering a trade, the potential risk must be determined. Where the stop will be place
should also be known before entering the trade. The effect of the placement of the stop on
risk, based on the size of the trade from the point of entry or from the current price, should be
calculated.
4. Check Potential Risk Against Personal Risk Guidelines
Personal risk guidelines should be determined based on what each individual trader considers
an acceptable risk. Once the potential risk has been established, it should be evaluated against
these personal risk guidelines. The risk used in determining whether a trade should be made
should always be less that what the maximum personal risk guidelines indicates. This forms
the second decision point in the trading system:
If the trade exceeds personal risk guideline limits, the trade should not be taken and
instead should be aborted.
If the trade lies within personal risk guideline limits, the next step should be considered.
5. Select The Entry Point
If personal risk guideline criteria are met, then the entry point into the trade should be
selected. In addition, at this time, the number of contracts and position size which will be
used should be decided upon. The entry point, trade size and stops are all connected with the
personal maximum risk limits.
6. Determine The Logical Exit
Once potential entry and risk have been assessed, the next step is to determine the logical exit
point for exiting the trade as well as whether the entire trade will be closed all at once, or if
some type of a scale out approach or strategy will be used.
Different trading systems can use different exit strategies. In addition to this, there are specific
rules for exiting harmonic trades which will be covered in more detail in later modules.
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The focus of any trader should be on finding the right set up, following pre-determined
guidelines and being consistent with trade execution. The money being traded should not be
the focus; instead the execution of the trade should be the focus. The system should be used
consistently, and maybe most important, the system should be kept simple.
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1.31 Consistency
Part of the reason a master trading plan is so important, is that it encourages consistent action
which, in turn, leads to consistent results. Achieving consistent results is what every trader
aspires to.
Consistency, however, is a word that many traders do not really understand. First of all it is
an action and not a result; consistency is not something which is gained. Instead, consistently
is a way to act. Over time, by acting consistently, consistent results are achieved. That does
not in any way imply that consistency will guarantee a winning trade every time. However, if
consistent results are not achieved, it is ONLY because the approach to trading which is being
taken is inconsistent.
Consistency only comes from actions and it is especially important to act consistently during
times of losses. Most traders fail to stick to a plan and jump ship to another plan, especially
after a string of loses, but this is when sticking to the plan and being consistent is most
important.
Any good master trading plan is simple and repeatable thus facilitating consistency. It should
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inherently show when where and why to enter a trade and, more importantly, when where and
why stops should be run as well as where a trading target should be.
1.32 Probability
It is no secret that to make money in the market a trader must buy low and sell high.
The trick however is to know when something is low or high. Most traders struggle with
this question, although many are not aware of it. The only way to reliable determine when
something is low or when something is high is by using probability. Probability is used when
a particular outcome can never be certain. A successful trader accepts the fact that they will
never know what is going to happen next and this is at least partially due to the fact that trading
is based on a non linear dynamical domain.
Non Linear Dynamical Domains
This may be an unfamiliar term, so to provide clarification, non
linear dynamical domain refers a set of data which is being
presented, in infinite amounts, in a seemingly random fashion, there
are an infinite number of things that can influence the data which is
presented, and the rules that govern the data being presented are
always changing.
A perfect example of a non linear dynamical domain is the weather.
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1.33 Leverage
The next concept that is critical to understand
is leverage. Leverage is a very powerful trading
tool. Unfortunately, a primary cause of traders
failing is that most traders unknowingly abuse
leverage.
Archimedes
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To illustrate the concept of leverage more clearly, examples will be described below:
Leverage example 1:
If you have a 100 lot, or contract, size and you have $25,000 in your account, your leverage
ratio will be:
Leverage example 2:
You have a mini contract which means you will be trading a 10,000 lot size and you have $5,000
in your account, your leverage will be:
It is worth remembering that the more lots which are traded using the same account balance,
the higher the leveraging of the account. This is illustrated in the next example:
Leverage example 3:
You have a mini contract and are trading a 10,000 lot size, have $5,000 in your account and
chose to make 3 trades, therefore your leverage will be:
Remember that less is more and rarely, if ever, should a leverage ratio of more than a 5:1 be
used.
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Anther factor which must be taken into account is that, in the market, stops can be gapped,
which is when the price moves through a stop order without trading at that price and so the
stop order is instead filled at the next available price, which may be very far away from where
to stop order was expected to be filled. This can result in larger than expected losses.
These factors mean that leverage should always be kept low, as sooner or later every trader
is to experience at least one stop gap. The key is to make sure that hitting a stop gap does not
altogether end the traders ability to trade. The only way to try and prevent that happening is to
ensure that leverage is kept low, even through a string of losses, so that so the trader lives to
trade another day.
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1.36 Reality
The reality is that losing and dealing with it is part of successful trading. Losing is part of
successful trading. Once that has been accepted as fact, a trading method can be built around
it. There is not and never will be a method that wins all the time so planning for the losing
trades in advance is simply prudent.
Having a clear understanding of leverage and risk limits, to help manage the reality of losing
trades, is the most important part of successful trading.
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Summary of Module 1
To summarize this first module of the Elemental Trader course:
Just as any successful business follows a business plan, a trader
should develop and follow a trading plan;
This trading plan should include criteria for set up, risk guidelines
and a methodology for trade entry management and exit strategy;
and
A trading plan is not a guarantee of success but a lack of a trading
plan is very commonly a guarantee of failure.
As stated at the beginning of this module, do not skip ahead and implement the plan without
first understanding the method, the chances of trading successfully will only be diminished if
time, which is necessary to learn the entire method, is not invested.
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Introduction to Module 2
This module discusses how patterns that are found everywhere around us can be translated
into recognizable repeatable patterns which, when applied to the market, can be used to
determine entries, stops and profit targets.
The objectives for this module are:
to become familiar with the Fibonacci sequence; and
to look at how Fibonacci rations, when applied to harmonic trading patterns, form the
Gartley Pattern.
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Because people tend to repeat themselves in comfortable patterns, that can be reflected in
market movement in charted patterns. Charted patterns are a reflection of human repetition in
the market, so in essence, it is not the patterns that are repeating themselves, it is the repeating
nature of people that are reflected as chart patterns. What is more, natural repetition can be
studied in charted patterns.
However, these repeating patterns are not new and are not only found in human nature as
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2.2 Fibonacci
Leonardo Fibonacci was a 13th century mathematician who played a
vital role in the introduction and the use of the Hindu Arabic numeral
system. Prior to his time, the most widely used numeral system or
number system was roman numerals.
Leonardo Fibonacci studied the natural repetition found in patterns
nature. One of his most widely known studies revolves around a
sequence of numbers that is commonly identified by his name, and
Figure 2.1
that is the Fibonacci sequence. Fibonacci also studied how that same
mathematical sequence could be applied to patterns that he observed everywhere around him
in nature.
Figure 2.2
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0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610...and so on into infinity.
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Within the sequence the each number is the sum of the previous two numbers:
0+1 =1, 1+1=2, 1+2+3, 2+3+5, 3+5=8, 5+8=13, 8+13+21, .and again into infinity.
Therefore, by adding any two adjoining numbers in the sequence, the following number is
generated.
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Figure 2.3
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more to know about Fibonacci and the Golden ratio than can be covered in this course. Indeed,
a full study of Fibonacci could fill an entire course in itself.
However, the study of Fibonacci and how it applies throughout the natural world is fascinating
and is a topic worth doing some personal research on and learning more about.
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The two Fibonacci ratios that will be the basis of harmonic trading are:
the Primary Fibonacci ratio of 1.618; and
the Reciprocal (11.618) Fibonacci ratio of 0.618.
From those two Fibonacci ratios additional useful ratios, needed to form the harmonic trading
patterns, can be calculated. These additional ratios are:
1.618 = 1.27
Found by taking the square root of 1.618 to obtain the 1.27 ratio;
0.618 = 0.786
Found by taking the square root of the 0.618 ratio to obtains the .786 ratio; and
0.786 = 0.886
Found by taking the square root of the 0.786 ratio to find the .886 ratio.
All of these ratios are important and fit within the patterns that harmonic trading can be based
upon. In use, all of these ratios are critical in calculating harmonic trading patterns, and the
base harmonic pattern that all other harmonic trading patterns are derived from is the Gartley
pattern.
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this pattern is named the Gartley pattern, the book did not discuss specific Fibonacci ratio
retracements. Instead, it was not until much later that specific Fibonacci retracements levels
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Figure 2.4
The diagrams in Figure 2.4 above illustrate two versions of the Gartley pattern, and as we can
see, this pattern develops in both Bull and Bear structures as a means of identifying potential
reversal levels.
Figure 2.5
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While at the beginning this pattern might look a little intimidating with all of the numbers and
letters and lines and dashes, in fact the Fibonacci ratios are only going to be used to determine
three points of entrance, the B point, the C point and the D point that we can see within the
pattern.
Point B is the most import ant level to find because it is the heart of the pattern. Without point B
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Finding point B starts at point X which in the Bear Gartley pattern begins at a relative high. This
may or may not be the highest point in the chart being viewed, however, the more extreme the
high the better, for the instance, the top part of a trend.
As the price falls from point X, it will continue to create new lows. At each dip, a new low is
formed until the price bottoms out at some point. It is not possible to determine when the price
is going to bottom, but it will bottom out at some point and this forms point A. This is now when
the real work begins, as up to this point, it has been a case of waiting for the market to move.
Now is when the Fibonacci ratios come into play. A measurement is taken from point A back to
point X and it is predicted that the price will return, within the Gartley pattern, back up to the
0.618 of the XA leg. Of course, just predicting the temperature for the day can only ever give
an approximation, the application of the 0.618 ratio is an approximation, but it should be pretty
close. This forms, Point B and as this is where the rest of the pattern develops from, it is a
critical point.
This can be seen in the chart example on the next page.
On chart 2.1, the Fibonacci levels have been inserted as horizontal lines highlighted in orange
between the point X and point A. Rising from point A, the market has returned back to the 0.618
level, as can been see highlighted in red right here to form point B. As can be seen, this is an
approximate level, and the market has, in this case, pushed just a few pips through the 0.618
level but is still pretty close.
From point B, as the market falls, it is possible to look for the formation of the next point which
is point C.
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Chart 2.1
Now it is natural that the question will come up Can I trade as the pattern develops? And yes,
of course it is possible to trade the B to C leg or the C to D leg as they develop, but it would be
like moving into a house before it is built. It might be fine for a little while, and sometimes it will
work, but it could come back crashing down around you. So as with the analogy, it is better to
wait until the full development of the harmonic pattern is completed.
As the market falls from point B, it moves back towards point A and from there, point C can be
measured and then defined. To find the point C retracement, the Fibonacci levels from A to B
are inserted and point C will match up with the approximate 0.382 Fibonacci ratio of the AB leg.
This can be seen on the following chart example.
On chart 2.2, the Fibonacci levels are highlighted in orange between the A and B points, the C
point has now been formed and as can be seen it fell from the B level all the way back down to
the approximate 0.382 level of the AB leg. In this case it pushed down through the 0.382 level
just a little bit, but for the most part held at the 0.382 Fibonacci retracement of the AB leg and
formed point C.
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After bottoming out at point C the market begins to rally again and goes back up and eventually
moves higher and eventually passes, Point B. Once the market moves past point B, the
formation of point D is expected at the approximate 1.27 level of the AB leg. This can be seen in
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Chart 2.2
On chart 2.3, again, the Fibonacci levels are inserted and highlighted between point A and point
B giving a reference for the formation of point D at the 1.27 Fibonacci level. As can be seen,
point D forms approximately at the 1.27 level and this completes the Gartley pattern and forms
what, in this course, is called the Potential Reversal Zone (PRZ).
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Chart 2.3
The PRZ is at point D and, as can be seen in Figure 2.5, point D not only matches up with the
1.27 level of the AB leg but also matches up with the 0.786 level of the XA leg which is a
good illustration of the harmonics at play within the Gartley pattern. This can be seen in the
following chart example:
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Chart 2.4
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Figure 2.6
Much like the Bear Gartley pattern, point B is going to be the most important point to find as
this is the heart of the pattern without which point C and point D cannot be determined. Finding
point B again starts at point X.
Point X in the Bull Gartley pattern starts at a relative low. Again, this may or may not be the
lowest point in the chart which is being viewing, but the lower the point chosen the better, the
most extreme low possible will be the best to form the pattern.
As the price rallies off of point X the chart will continue to create new highs. Again, you do
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not know when these highs are going to stop, it may find a high, surpass that, find a new high,
surpass that, find a new high, and keep going, but eventually the price tops out at some point
and this forms point A.
Now is where the real work is going to begin again and the Fibonacci ratios can be applied.
Taking a measurement from point A back up to point X, the price is expected to return back to
the 0.618 level of the XA leg to form point B. This can be seen in the chart diagram below:
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Chart 2.5
On chart 2.5, the Fibonacci levels have been inserted in orange between point X and point A and
the market returns back down to the 0.618 level to form point B.
Once point B is formed, the market begins to rally again and starts to go back up. From point
B, as the market rallies towards the point A level, it is possible to measure and look for the
formation of point C by inserting the Fibonacci levels from point A back to point B. Point C is
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going to form when the market tops out somewhere between the 0.382 level and the 0.886
level of the AB leg. Once, the market forms a peak, it will have formed point C. After topping out
at Point C, the market will eventually begin to fall again. The creation of point C can be seen in
the following chart example:
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Chart 2.6
As can be seen in Chart 2.6 the Fibonacci ratios between point A and point B have been have
been inserted in orange whereby the bottom is 0 and the top is 1 (or 0% and 100% respectively.
From point B, the market comes back up to the 0.886 level, or comes back up 86%, of this
Fibonacci range.
As the market falls from point C it goes down and surpasses point B after which point D will be
formed. Point D is between the 1.27 level and 1.618 level of the AB leg. These Fibonacci ratio
levels have been inserted in the following chart example:
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Chart 2.7
As point D is going to be formed between the 1.27 level and 1.618 level of the AB leg, this
provides us with an estimate as to where point D will be formed. Once Point D has been formed,
this completes the Gartley pattern. At this point, point D also becomes the PRZ.
Not only are the PRZ and Point D found between the 1.27 level and 1.618 level of the AB leg,
but by harmonic alignment, the 1.27 level or 1.618 level of the AB leg should harmonize and
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come into alignment with the 0.786 level of the XA leg. This can be seen on the following chart
example:
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Chart 2.8
In chart 2.8, the Fibonacci ratios between point X and point A have been inserted and, as can
be seen, all the way down at the bottom of the PRZ is the 0.786 Fibonacci ratio of the XA leg.
Therefore, as can be seen, this point D, the 0.786 Fibonacci level of the XA leg and the 1.27 or
1.618 levels of the AB leg, all convergence to form the PRZ, or potential reversal zone, where,
in a Bull Gartley pattern, the market is expected to turn around and start going back up.
Summary of Module 2
This module has explored that people, being creatures of habit, tend to gravitate to things that
are familiar and comfortable and in doing so, are likely to repeat themselves iteratively. This
natural repetition can be studied throughout nature and recognized in patterns.
Fibonacci represented these patterns through mathematical ratios and using these patterns
and ratios as Gartley patterns, it is possible to determine with high probability the location of
potential reversal zones in which a market is most likely to change direction. Understanding
these patterns can provide traders with potential entry points, stop levels to manage risk and
even profit targets.
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These patterns, like the Gartley pattern, will all be visually identified using the Elemental
Trading software.
An important aspect of each of these patterns is that all of them can be identified and traded
on any time frame. This means that a Gartley formation on a five minute chart can be just
as useful as a Gartley that forms on a four hour chart. However it is worth bearing in mind
that, depending on the time frame on which you are trading, potential stops and profit may be
smaller or larger.
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In any case, no matter whether the trading is taking place on a small or large time frame, point
D is going to represent the point when potential reversal may occur and this is known as the
PRZ.
D, or the PRZ, is above point X in a Bear pattern and below point X in a Bull pattern. Often, with
the butterfly pattern the PRZ smaller and more precise than other patterns and as a result, this
can provide greater trading opportunities.
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Figure 3.1
To the novice harmonic trader this may look like a breakout to the downside. However, as the
harmonic Fibonacci ratios are applied to the pattern, it is possible to discern when reversal
could happen and what initially appeared to be a breakout turns into a false break and a
reversal.
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Whilst, like the Gartley pattern, this may initially appear a little intimidating, in effect the
Fibonacci ratios are simply being used to determine three points of interest, point B, C and D.
Point B is again the most important level to find first as it is needed to find point C or point D.
Point B is found by starting with Point X. Point X in a Bull Butterfly pattern begins at any relative
low, which may or may not be the lowest point on the chart being viewed but the lower point
chosen, the better.
As the price rallies from point X it will continue to create new highs on each new rise, until the
price eventually tops out at some point forming point A. The Fibonacci ratio can then be applied
to the chart. Taking a measure from point A back to point X, the price is predicted to return back
to the approximate 0.786 level of the XA leg and this is where point B will form, as can be seen
on the following chart example:
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Chart 3.1
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To give some perspective of the time that these patterns take to develop on larger
compressions, it is worth noting that Chart 3.1 is the GDP USD daily chart. This pattern began
to develop back in October of 2010 and took almost 6 weeks, until the end of November, to
develop.
On chart 3.1 the Fibonacci levels have been inserted in orange between point X and point A and
as can be seen the market returns very close to the 0.786 level to form point B.
The market then begins to rally from point B and move towards the level of point A making it
possible to measure for the formation of point C. To find the point C retracement, the Fibonacci
levels from point A to point B are inserted into the chart as can be seen in the following
example:
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Chart 3.2
Point C is formed between the 0.382 or 0.886 Fibonacci ratios of the AB leg and on chart 3.2
the Fibonacci levels have been inserted in orange between the A and B points. In this case, the
price has risen to and slightly surpassed, the approximate 0.382 level of the AB leg forming
point C.
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After topping out at point C the market then falls and eventually surpasses point B and will
continue to fall to form point D as can be seen in the following chart example:
Chart 3.3
Once the market reaches approximate 1.27 level or 1.618 level of the XA leg of the pattern,
point D is formed. This can be seen on the following chart example:
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Chart 3.4
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On chart 3.4 the Fibonacci levels have been inserted from point X to point A and this give us
a reference point for the formation of point D at the 1.27 level of that XA leg. Once Point D is
formed this completes the whole Bull Butterfly pattern and has forms the PRZ, the zone in
which reversal may occur.
The following diagram shown in Figure 3.2 illustrates a Bear Butterfly Gartley pattern:
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Figure 3.2
Much like the Bull Butterfly pattern, point B is most important level to find first, as this in
needed to move on to point C and point D.
Finding point B once again starts at point X which on a Bear Butterfly pattern begins at a
relative high. As the price falls from point X it will create new lows on each new fall until the
price bottoms out at some point forming point A.
Using Fibonacci levels applied from point A back to point X, the price is expected to return back
to the approximate 0.786 level of the XA leg to form point B. This can be seen on the following
chart example:
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Chart 3.5
It is important to note that Chart 3.5 is the Euro USD four hour chart, and this pattern began
development on October 15th and it took about 3 weeks, until November 4th, to develop.
On chart 3.5 the Fibonacci levels have been inserted in orange between point X and point A and
as can be seen, the market returns approximately to the 0.786 level to form point B.
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From point B, as the market falls towards point A, it is possible to measure now for the
formation of point C as can be seen in the following chart example:
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Chart 3.6
To find point C, the Fibonacci levels from point A to point B are inserted and point C will be
formed at the approximate 0.382 or 0.886 Fibonacci ratio of the AB leg. In this case, the market
has returned back down to the 0.886 of the AB leg to form point C. And after bottoming out at
point C the market then rises and eventually surpasses point B.
Once it does, Point D is formed at the approximate 1.27 level or 1.618 level of the XA leg of the
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Chart 3.7
On chart 3.7, the Fibonacci levels are inserted from point X to point A giving us a reference
point that forms point D at the 1.27 of the XA leg. Once Point D has been formed, the pattern is
completed and the PRZ or potential reversal zone, the zone in which reversal may occur and
this currency may begin to go back down, is formed.
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thus can require smaller stop loss placement meaning the risk to reward ratio is often the best
for the Crab pattern. Unfortunately, the crab is generally the most infrequent of the patterns
and some patience may be required in waiting for this pattern to form and show up. However,
the reward from this pattern is often well worth the wait. The Crab pattern is similar to the
Butterfly pattern in that it may start off looking like a breakout.
pattern:
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Figure 3.3
Much like other Gartley patterns, point B is the heart of the pattern as it is required to move on
to the rest of the points. Finding point B starts at point X which in a Bull Crab pattern begins at a
relative low, which may or may not bee the lowest point of the chart but the more extreme low
chosen the better.
As the price rallies from point X, it will continue to create new highs on each new rise until the
price tops out forming point A. Taking a measure from point A to point X, the price is expected
to return back down to the approximate 0.382 level or 0.618 level of the XA leg to form point B.
This can be seen on the following chart example:
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Chart 3.8
Chart 3.8 is the Euro GDP fifteen minute chart which provides some perspective of the time
it took to develop this pattern. This pattern began development late on December 8th and
completed about midday the next day, December 9th.
The Fibonacci levels have been inserted between points X and A and the market returns to the
approximate 0.382 level to form point B from where it begins to rally.
Once point B is established, it is possible to look for the formation of point C as the market
moves back towards point A as can be seen on the following chart:
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Chart 3.9
The Fibonacci levels have been inserted from point A to point B, Point C is formed when the
market reaches between the approximate 0.382 or 0.886 level of the AB leg. On this chart point
C is formed at approximately the 0.886 level of the AB leg.
Once Point C is formed the market then begins to fall and eventually surpasses point B after
which Point D will be formed between the approximate 0.127 or 1.618 levels of the XA leg of
the pattern as can be seen on the following chart example:
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Chart 3.10
On chart 3.10 the Fibonacci levels have been inserted in orange from point X to point A giving a
reference point and in this case, point D forms at the 1.618 of the XA leg.
The formation of point D completes the pattern and forms the as can be seen in the following
chart:
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Chart 3.11
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The following diagram shown in Figure 3.4 illustrates a Bear Crab pattern:
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Figure 3.4
Like all other harmonic patterns which have been discussed, point B is the most important
level to find first and finding point B starts at point X. Point X, in a Bear Crab pattern, begins at a
relative high which may or may not be the highest point on the chart that is being viewed.
As the price falls from point X it continues to create new lows on each fall until the price
bottoms out forming point A. Taking a measure from point A back to point X the price is
expected to return back to the 0.382 or the 0.618 of the XA leg to form point B. This can be seen
in the following chart example:
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Chart 3.12
Chart 3.12 is the GDP USD 15 minute chart and this pattern began development on December
9th and completed on December 10th. On this chart, the Fibonacci levels have been inserted
between point X and point A, and the market returns to the approximate 0.618 level to form
point B before it begins to fall once again.
As the market falls from point B, it is possible to measure for Point C by inserting the Fibonacci
levels from point A to point B as can be seen on the following chart example:
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Chart 3.13
Point C is formed between the approximate 0.382 or 0.886 of the AB leg. On chart 3.13 the
Fibonacci levels have been inserted between point A and point B and the price has now fallen to
the approximate 0.382 area of the AB leg forming point C.
After bottoming out at point C, the market rises and surpasses point B. Point D is formed after
the market passes point B and climbs to the approximate 2.24 or 3.681 levels of the AB leg of
the pattern as can be seen on the following chart example:
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Chart 3.14
On chart 3.14, the Fibonacci levels have been inserted from point A to point B giving a reference
point for the formation of point D at the approximate 2.24 level of the AB leg.
Point D completes this pattern and forms the PRZ or potential reversal zone as can be seen in
the following chart example:
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Chart 3.15
Point D, or the PRZ, represents the zone at which reversal, after the completion of the pattern,
may occur.
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Bat pattern:
Figure 3.5
Once again, finding point B starts at point X. Point X in the Bull Bat pattern is at a relative low.
As the price rallies from point X it will continue to create new highs at each rise until the price
tops out at some point forming point A.
Taking a measure back from point A to point X, the price is expected to return back to the
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approximate 0.50 or 0.382 levels of the XA leg. This can be seen on the following chart
example:
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Chart 3.16
This is pattern is shown on chart 3.16 which is the CAD JPY daily chart and this provides a
perspective of the time it took to develop this pattern. This pattern began development in late
August and completed in about mid October.
On chart 3.16, the Fibonacci levels have been inserted between point X and point A, and the
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market has returned to the approximate 0.382 level to form point B before beginning to rally
once again.
From point B it is possible to look for the formation of point C so as the market rallies and
moves towards point. The point C retracement can be found by inserting the Fibonacci levels
from point A to point B as is shown in the following chart example:
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Chart 3.17
Point C occurs between the 0.382 or 0.886 Fibonacci ratios of the AB leg. As can be seen above,
the price has risen to the approximate 0.382 level, forming point C.
After topping out at point C the market begins to fall once again and eventually surpasses point
B after which point D is formed at the approximate 0.886 level of the XA leg of the pattern as
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Chart 3.18
On chart 3.18, the Fibonacci levels have been inserted from point A to point X giving the
reference for the formation of point D at the 0.886 of the XA leg.
As can be seen on the following chart example, Point D completes this pattern and forms the
potential reversal zone.
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Chart 3.18
Chart 3.19
Point D, known as the PRZ, represents the point at which reversal may occur and the market
may begin to rally.
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The following diagram, shown in Figure 3.6, illustrates the Bear Bat pattern:
Figure 3.6
Finding point B starts at point X and, in the Bear Bat pattern, point X is at a relative high. As the
price falls from point X it will continue to create new lows on each fall until the price bottoms
out at some point forming point A. The price is then expected to return back to the approximate
0.382 or 0.50 of the XA leg to form point B. This can be seen in the following chart example:
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Chart 3.20
Chart 3.20 shows the USD CHF weekly chart and this pattern began development in the
February and did not complete until April. On chart 3.20 the Fibonacci levels have been inserted
between point X and point A and the market has returned to the approximate 0.50 level to
form point B. As the market falls from point B it is possible to look for the formation of point by
inserting the Fibonacci levels between point A and point B. Point C is formed when the market
is between the approximate 0.382 or 0.886 ratios of the AB leg.
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Chart 3.21
On chart 3.21 the Fibonacci levels are shown between point A and point B and as can be seen,
the price has now fallen to the approximate 0.382 level of the AB leg where point C is formed.
After bottoming out at point C, the market rallies and rises surpassing point B. Point D will be
formed as the market passes point B and reaches the approximate 0.886 level of the XA leg of
the pattern as can be seen on the following chart example:
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Chart 3.22
On chart 3.22 the Fibonacci levels are inserted from point A to point X giving the reference for
the formation of point D at the 0.886 of the XA leg.
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Chart 3.23
The formation of point D completes the pattern and forms the PRZ, the zone in which reversal
may occur.
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where the PRZ is and in a later module the use of the PRZ as an entry area will be explored. The
PRZ will also be used to develop risk guidelines and potential stop placement.
Summary of Module 3
This module has explored the use of harmonic patterns and ratios to determine, with high
probability, potential reversal zones in which the market is most likely to change direction.
Understanding these patterns can provide traders with potential entry points, stop levels to
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First go into My Computer then find the C Drive. Within the C drive find Program Files
and within this, find the folder for the broker that is being trading with. Next, go into Experts
and finally go into the Indicators folder.
The Elemental Trader icon can then be dragged and dropped from the desktop into the
Indicators folder and this window can then be closed.
It is now possible to log into the brokerage platform being used and finish the installation of
the Elemental Trader software.
Once the brokerage platform is open, pull up a new chart window by going to the Market
Watch icon and clicking on the pair of currencies to be traded. Then chose the Chart Window
option and a new chart is opened.
Now, go to Custom Indicators and double click on the Elemental Trader icon. Once at this
screen, on the Common tab, there is no need to select to allow DLL imports, instead, OK can
now be clicked.
To complete the installation, the brokerage platform must be closed and then reopened. The
installation is now complete and by scrolling through different time compressions it is possible
to see the different numbers, variables and patterns being displayed in real time.
Once the Elemental Trader software is successfully installed onto the trading charts, it is time
to begin trading.
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Chart 4.1
The candlesticks and background color of the screen may be different on your charts and these
features which are customizable so can be set to suit personal taste. However, the Elemental
Trader indicator colors of the triangles, pattern lines, Fibonacci ratios and PRZ designation are
pre-set. Within the text at the top left of the chart 4.1, the identified signal is being indicated, in
this case it is indicating a Bear Bat pattern.
The Elemental Software does the work of applying the proper Fibonacci ratios to each leg of the
pattern. The PRZ is highlighted by the red box which can be seen here at the top right hand side
of the chart.
Whilst it is not necessary to understand how the Fibonacci ratios apply to the chart to form
the patterns in order to be able to trade them, it can be very helpful to understand how they fit
within the construction of the patterns and interpret some of the lines that can be seen on the
charts.
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Figure 4.1
The two main points are point B, from which much of the pattern is based, and the ratio for
which is shown highlighted in blue; and point D, or the PRZ in which reversal is most likely to
occur, the ratio for which is highlighted in yellow.
In the Bear Crab pattern, point B is formed when the market retraces the XA leg, in this case,
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up to the 0.618 Fibonacci level. Looking at the chart 4.2 shown below it can be seen how the
software enumerates this retracement with the Fibonacci ratio that is highlighted here in blue.
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Chart 4.2
On chart 4.3 shown below, the discovery of point D is shown. Within the Bear Crab pattern,
point D is formed when the market reaches the approximate 1.618 of the XA leg which in this
case is highlighted by the yellow box.
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Chart 4.3
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At this approximate ratio, point D, or potential reversal zone where reversal is most likely to
occur, is formed and this is shown in the chart 4.4 below:
Chart 4.4
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Chart 4.5
Chart 4.5 is the Euro AUD fifteen minute chart and it is showing a bearish crab signal or pattern.
And in this case, the bottom of the PRZ rests at about 1.3160 and the top of the PRZ is around
1.3180 meaning that the PRZ is about 20 pips from the bottom to the top.
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Risk
Applying the risk strategy from the master trading system indicates that the stop should be
placed between 1.3193 and 1.3214.
To determine potential risk, use the average price of the PRZ as the entry price. The average
price between the 1.3160 and 1.3180 limits of the PRZ is 1.3170, so this is used as the potential
entry price.
Using a 20 pip stop above the PRZ, the stop should be placed at about 1.3200. To determine
total risk, divide the PRZ in half, in this case 20 pips divided in half is 10, then add to this the
stop of 20 pips above the PRZ which gives a total risk of 30 pips if this trade was to be entered.
However, risk is only half the equation and it is necessary to be sure that potential reward
outweighs any potential risk, and to do this it is necessary to determine the potential profit.
Reward
As was mentioned above, the Elemental Trader software helps to determine the risk and
reward associated with any given trade. As a rule of thumb, point B is used to determine
potential reward as can be seen by looking again at the chart example:
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Chart 4.6
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In chart 4.6, point B rests around 1.3098, so from the entry price at 1.3170 down to the point B
level of 1.3098 gives a potential profit of 72 pips.
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have been 50, 80 or 100 pips or more, depending on the type of pattern that is being looking at
or even depending upon the time frame on which the pattern is being looked at.
Another issue which is worth noting is that a harmonic pattern may be found on a certain
brokers chart, but may or may not be seen on a different brokers chart. Why does this happen
that? Well, it is simply due to the fact that the Forex is a non-centralized market and each
brokers feed may be just that little bit different. However, just because the pattern can only
be found on one chart does not mean that the pattern does not exist, the Elemental Trader
software is designed to identify a pattern signal within certain variances and if they are not met
they will not show on that particular chart. Going back to the analogy of predicting the weather,
nothing is exact in a non linear dynamical domain.
A key factor, which needs to be taken into consideration when an entry procedure for a trade is
being determined, is:
Scaling
As the PRZ is not an exact point, it is best not to put all your eggs in the one basket so to speak.
For instance, at the bottom of a Bear PRZ when there is the potential for the market to continue
to move higher within the PRZ by 20, 50 or 100 pips, it would be possible to ease into the trade
by breaking the maximum lots available to be traded into several smaller lot trades.
Scaling is a mechanical process for entering the trade, using a series of predetermined
entry points, within boundaries of the PRZ. Scaling can be mechanized to the point that the
predetermined entry points can be preset and no further intervention is required for the trade
to occur.
Having a mechanical process of easing into a trade, helps eliminate the influence of emotions
in the trading process. If a trader had entered their maximum lots all at once, and the market
then squeezed a little bit higher within the PRZ, there is a risk that negative emotions will take
control causing fear and may lead to the trader close the trade too early for fear of a huge loss
being sustained. There is no way of knowing the exact point in time or price that the market will
turn and therefore it is worth bearing in mind that the market could in fact squeeze a little bit
higher. Thus, every trader should always be prepared for what may come.
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When implementing a scaling approach entry, ideally the orders should be scaled such that if
all entries are executed, the average entry price is about 50% of the PRZ.
Taking another look at chart 4.5, a scaling approach to entry could be taken. In this case, the
PRZ goes from 1.3160 to 1.3810. If the maximum lots tradable is equal to $100,000 or 10 lots
then this should be broken down into smaller lot trades. In this case for example, the first scale
entry could see three lots entered at 1.3160, which is the bottom of the PRZ. The second scale
entry could be four lots entered at 1.3170, which is the middle of the PRZ. The third scale entry
could be the remaining three lots entered at 1.3180 near the top of the PRZ. These entry levels
can be predetermined and, using the Elemental Trader software, set as entry orders even at the
beginning stages of the pattern set up.
Even when using such a mechanical entry process there are variables which can affect the
trade. The preferred number of trade entries and the preferred trade size will be different for
every trader and may even be different for every trade scenario. In addition, even though the
entry points may be predetermined, it does not always mean that all of the orders will be filled.
It should also be remembered that the PRZ is a potential reversal zone, and that reversal could
occur at any point within that PRZ, even at the beginning of the PRZ.
However, taking factors like these into account, it is better, for example, to be in one small trade
at the beginning wishing that more had been traded when the market reverses than it is wishing
that less had been traded when maximum lots were traded at the beginning and the market
doesnt reverse.
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There are two points at which the stop can be moved. The first of these is when the market
moves 50% back to point B, which is the profit target from the entry price. The second of these
is when risk has been overcome and this will typically be determined by the average entry price
and whether one entry or four entries were made.
Looking again at chart 4.5, the average entry price was 1.3170. Point B, the profit target, was
1.3098 so a 50% move towards point B takes the market back to 1.3134. At this point, it is
worth considering moving the stop from 20 pips above the PRZ, at 1.3200, towards break even
or even scaling out of the trade with some profit.
However, if the trade had been scaled into with an average entry price of 1.3170, the market
only needs to move back to 1.3140 to overcome any risk on the trade.
This can be seen illustrated in the following chart example:
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Chart 4.7
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In chart 4.7, the entry price at 1.3170 which is 50% of the PRZ. The potential profit target
is point B at 1.3098 and when the market moves 50% back towards point B it is a good
opportunity to lock in break even and thus eliminate risk. Once risk is no longer a factor, the
focus can be moved to taking profit. So in the same way that scaling into a trade is useful to
control emotions, scaling out is also useful to control emotions. In a way, scaling out satisfies
the urge to take profit while leaving a little bit of the trade on for larger movements.
The caveat to all of this is that it is impossible to ever know where the market will go.
Therefore, it is worth considering which is worse:
getting out with small profit and watching the market keep going, or
going back to the break even stop and ending up with nothing.
Whatever of these options is worst means that it should be the other option which is
implemented.
As detailed above, one approach to scaling out could be that when the market moves halfway
back to point B then risk can be eliminated by moving the stop to break even thus, taking a
portion of the profit at that time to ensure something is gained from the trade. This process
of moving the stop can be followed until point B has been reached at which time it would be
recommended that at least a majority of the position is closed or a majority of the profit is
locked in if the decision is taken to let the trade ride longer.
Summary of Module 4
This module outlined the procedures for obtaining and installing the Elemental Trader software
and then discussed how to identify the signals provided by the Elemental Trading software as
they appear.
In addition, recommended guidelines for risk, reward, entry and trade management using
harmonic trading patterns were explored and these guidelines will be useful in tempering the
influence of emotions on personal trading.
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Module 5 Personal
Trading Plan
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Introduction to Module 5
This module will explore the development of a personal trading plan which is an important
aspect of successful trading. The reasons why a personal trading plan is needed and the steps
necessary to developing a trading plan that is personalized will be outlined before how the plan
can be implemented is explored.
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When setting personal trading goals, it is important to be specific, they dont need to be long
drawn out paragraphs but short to the point statements about the goals including a starting
point, milestones along the way and an ending point. Short term, mid term and long term goals
should be included to ensure progress can be measured along the way.
Stating I want to make a million dollars trading doesnt map out a plan to achieve that goal;
instead it just becomes more like a dream than a goal.
Goals should be realistic, measurable and time based.
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the chances of sticking to a trading plan are better which in turn will lead to successful trade
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decisions.
A routine is consistent, familiar and mechanical and developing a routine makes following a set
of guidelines easier.
Follow Guidelines
Guidelines are the map that will be followed during trading, and the map provides the steps to
follow before entering a trade and specific guidelines about capitalization, risk and leverage
management as well as about management of open trades and evaluation of those trades
after they have closed. Guidelines help with trade management and account management and
guidelines should always be followed.
Evaluate Performance
If personal goals are sufficiently specific, then there should be milestones along the way
against which progress towards personal goals can be compared. These milestones help
facilitate evaluation of trading performance. Performance can be evaluated in two difference
ways, namely:
trade performance can be evaluated; and
trading performance can be evaluated.
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Evaluating trade performance means evaluating performance of a single trade and this involves
looking at the specific trade tactics of each individual trade: did it go as expected? What if any
thing could be done differently on the next trade?
Evaluating trading performance means evaluating the progress towards personal trading goals:
have the milestones which must be met in order to meet the goals set for the overall personal
trading plan been achieved?
Therefore, to be a successful Forex trader, it is invaluable to have a personal trading plan as a
personal trading plan means:
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Setting shorter term and longer term goals facilitates ongoing evaluation of progress.
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trading goal ensures that live goals for real money trading are realistic and attainable.
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By developing a demo trading goal and then trading on a demo account first, analysis skills
necessary for making informed trade entry decisions are developed. Using a 3 month demo
account trading period is sufficient time to:
develop analysis skills
create a disciplined daily/weekly trading routine
establish a baseline win-loss record
gain experience with controlling emotions
develop proficient dealing station skills
establish realistic live account goals
In other words, using a demo account will help create a trading routine which will minimize the
risk of emotions controlling trading decisions and by establishing a win loss record on a demo
account it is possible to measure how successful trading goals are being reached. Demo trading
is also where execution skills on the dealing station can be developed safely. By using a demo
account, all of these aspects of trading can be established without risking real money in a live
trading account.
Demo trading also helps realistic trading goals to be developed. For example if, after trading
for three months on a demo account only a 5% return has been achieved, is it not particularly
realistic to believe a 50% return could be achieved on the same basis on a live account.
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Successful demo trading will increase the likelihood of overall trading goals being attained. The
importance of a sustained period of demo trading in improving the likelihood of success in live
Forex trading cannot be overstated.
Spend
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currency pairs
hours per day studying and trading
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x account balance
pips of profit
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Consider the acceptable limits for total exposure, an example of maximum overall market
exposure may be 5x account balance. The key is to set a guideline that will keep exposure
manageable, which will limit risk and increase sustainability in the market.
Guidelines should be developed for setting stop loss levels that meet with the aim of moving
towards overall trading goals. Setting a guideline for moving a stop after a certain number
of pips, will help protect from significant losses. Once a stop is committed to, it should not
be moved just to stay in a trade as this would be risking letting emotions take control rather
than keeping it mechanical. A guideline should also be set for periodically checking progress
towards trading goals at specific milestones.
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In addition, once the stop has been determined, it is important to establish potential gain, the
reasons for the target limit and if there is there enough profit potential to justify the size of the
stop.
Whilst a home runner shouldnt be aimed for on every trade, progress towards personal trading
goals should.
to exit a trade and then evaluate the performance of that trade. These rules provide the means
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necessary to evaluate each success and failure and disciplined use of the specific trade tactics
will promote success.
Entering The Trade
This involves looking at the process that leads up to entering a trade and developing specific
trade tactics that can apply to and be recorded for each individual trade entered. This is an
important aspect of the personal trading plan.
Keeping track of the trade criteria for every trade can be achieved, by, for example recording
the following details:
Currency pair:
Summary of analysis:
First, the currency that is being traded should be noted and then a note summarizing all
that has been considered. Why is this trade being entered? What harmonic pattern is being
signaled? Once potential entry point has been found, the next steps in the trading process
should be examined and the following information noted:
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Determine stop
Determine limit
The noted information will be useful later for trade evaluation purposes. If, on applying the
trade tactics a decision to make the trade is taken, it is worth also noting the spread or swap for
the currency being traded and what is the entry price as well as ensuring that the decision to
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trade is not being based on emotions. After all this, it is time to enter the trade.
Managing the Trade
Once a trade has been entered, the next stage of the process is trade management. Trade
tactics can be employed in one of two different ways to manage a trade.
On the one hand, stop loss and limit settings set up within the trading software can be left do
their job. This means the trading process requires is less screen time, as it is not necessary to
sit and stare at the charts. In addition, this tactic reduces the chance that emotions will take
control of the trade scenario by keeping the process mechanical.
Alternatively, the performance of the trade can be tracked and the stop can then be managed.
Managing the stop helps prevent loss. Moving to break even helps eliminate risk and by
following the trade with the stop it may be possible to lock in profit and let the trade ride. Then,
once the trade is complete you will look to close the trade.
Exiting The Trade
Several different tactics and be employed for closing a trade. In most cases, the trade may be
closed when it has reached a limit level; the limit reached could be that daily or weekly profit
goals have been met. The trade may alternatively be closed because it failed to meet the price
movement expectations and therefore there is a desire to reduce the amount of risk or exposure
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Whilst these might seem like time consuming details, evaluating trades and keeping track of
performance involves an attachment to the trading process instead of just being a bystander on
the guidelines.
A trading journal may also be kept. Just like any successful business evaluates performance
and activities of each employee on a regular basis, a trading journal is a primary tool for
evaluating the effectiveness of personal trading strategy and tactics.
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sustainability within your trading approach. Choosing the currency pair to trade will help to
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focus trading and reduce the amount of screen time necessary. The time frame traded may
depend on the type of trading which is being undertaken. An internet trader may want to focus
on smaller time frames whereas a position trader, or longer term trader, may focus on larger
compressions. It is possible to choose to trade all harmonic patterns or to trade just one
harmonic pattern. The minimum risk reward ratio is different for everyone as some traders
have a risk tolerance greater than that of other traders.
The following is a sample personal trading plan put together by Derek Frey using the criteria
outlined above:
Maximum loss limit:
1%
Currency Pairs:
EUR/USD
GBP/USD
USD/CHF
AUD/USD
USD/CAD
USD/JPY
Time Frames:
As you can see, this example personal trading plan uses a maximum loss limit of 1%, lists out
particular currency pairs that will be focused on and the time frames that will be focused on,
and the types of patterns that will be focused on, in this case the Gartley and other harmonic
patterns. The acceptable risk to reward ratio is then determined. Also, in the nifty fifty plan, a
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trading plan in which the guidelines set out that that trades should enter harmonic patterns at
50% of the PRZ, the stops are run 13 to 34 pips outside the PRZ, the first target is a move back
to the price of the B point of the original pattern and that stops should be moved to break even
once the trade moves 50% back towards the targeted zone and scaling out should then begin.
Of course having a plan like this is a great start but it is not really enough. The hardest part
of any trading plan is sticking to it and this is the real challenge for any trader. Ideally, in
order to succeed, a plan should be tried for no less than 100 trades before giving up on it.
As commitment should be shown to a personal trading plan, it is important that when it is
constructed, it reflects personal visions and goals to give direction to the trading process.
A personal trading plan is not a guarantee of success, but the lack of a personal trading plan is
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Summary of Module 5
This module has focused on importance of a personal trading plan and how vital it will be to
trading success.
As a personal trading plan is developed, remember to be specific and include guidelines that
are realistic, measurable and time based. A trading plan should provide the guidelines to follow
prior to entering a trade, through trading strategy with rules that limit risk and exposure. A
personal trading plan also should include rules to follow for entering a new trade, managing
that trade and after the trade has closed evaluation that trade and the progress towards
personal trading goals.
Putting a personal trading plan into practice on a demo account will help to ensure success
upon progression to a live trading account with real money and it should improve the likelihood
of attaining personal trading goals. Every trader should take time to develop a personal trading
plan before risking money in the Forex.
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Module 6 Money
Management
money management
Introduction to Module 6
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An important part of personal trading plan is adhering to sound money management practices.
This module will explore money management whilst continuing with the development of a
personal trading plan by approaching trading on the Forex as a business, by understanding the
need of sufficient capitalization, developing appropriate leverage guidelines and also developing
sound risk management guidelines.
A calculator may be help in working through some of the exercises later in this module.
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Proper account awareness does not only mean knowing where an account is held but also
knowing how much is in the account, how much is currently being committed from the account
for open trades, what the floating net profit or loss is and what amount of account capital is still
available for opening new trades or holding current trades. It is important to keep track of all
transactions at all times
money management
decisions are mechanical and not based on any emotional response to the market.
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A few losses here or there does not mean the plan has failed it could just be volatility in the
market.
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money management
Table 6.1
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And there are a few other considerations when it comes to account capitalization such as
the type of trading being undertaken. Long term traders need to be able to ride the swings of
natural ups and downs of a currency, so more capital and less leverage would be necessary.
Short term traders may need less capital than a long tern trader because they are typically
using smaller stops and not expecting to ride out swings but they do need enough to withstand
periods of drawdown.
However, perhaps the most important aspect of capitalizing a trading account is that only risk
capital should be used. This means that the only funds which should be used to capitalize a
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trading account are those that the loss of can be afforded. Properly funding a trading account
helps to ensure to withstand those periods when the market just doesnt return gains, even
when a trading plan is being adhered to strictly.
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Table 6.2
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money management
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Table 6.3
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6.31 Leverage
Leverage allows a trader to fully control a large amount of currency in a trade without being
required to fund the full amount of the trade. It is important to realise that regulations can
change from time to time and may be different from what are shown in table 6.4 below.
money management
Table 6.4
As can be seen in table 6.4, with a standard account, the amount controlled per lot is $100,000.
If the leverage set up with the broker is 50:1 the margin required from the trader is $2000 to
control that $100000. If the leverage set up is 100:1 then the margin required per lot from the
trader is $1000 dollars to control that $100,000 standard lot. So as you can see the $ amount
required from the trader, also known as the margin, depends on the leverage level set up with
the broker.
Typical leverage levels are- 50:1, 100:1, 200:1 or 400:1. The higher the leverage level, the
smaller the amount required from the trader. Leverage is a multiplier that increases the
traders ability to control a high amount of volume in the market.
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The level of leverage is usually set up by the broker when a trading account is opened.
Table 6.5
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As can be seen in table 6.5, if a mini-account was opened with $5000 dollars, leverage of 100:1
provides the ability to control $500,000 of volume in the market. This is because at 100:1
leverage the margin required is $100 per lot traded on a mini account. With $5000 dollars in
that mini account $5000 divided by $100 per lot equals 50 lots. 50 lots at $10,000 control will
leverage per lot equals $500,000 controlled.
Now just because it is possible to expose an account to such a level or risk does not mean that
an account should ever be exposed to that much risk. Overloading an account to the maximum
increases the chances of receiving a margin call. With a good trading plan the margin will never
exposed to this amount of risk.
Indeed, it is recommended that total exposure in the market at any time is limited to a volume
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no greater than 5 times the account balance. By using this prudent approach, open trades can
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be better managed thus allowing greater flexibility. Using minimal leverage reduces the amount
of risk that the account is exposed to and promotes sustainability. Establishing and adhering to
risk guidelines in relation to leverage is an integral part of Forex trading success.
Here are some examples of how controlling volume controls the amount of exposure placed on
an account balance.
Example 1
This scenario involves a mini account with $6000 balance. The trading plan
guidelines limit the exposure to 5x the account balance which is $30,000, $30,000
divided by $10,000 control per mini lot limits trading to a maximum of 3 mini-lots
committed to all open trades at any one time.
Whilst this example looks at a mini account, the same rules can supply to a standard trading
account as can be seen when trying to establish the number of lots that should be committed to
all open trades in the following example:
Example 2
A standard account has a balance of $40000 dollars and exposure guidelines are
set at 5x account balance,
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$40,000 x 5 = $200,000
Therefore $200,000 is maximum volume to expose the account to in the market.
$200,000 $100,000 controlled per lot = 2 standard lots
Therefore, 2 standard lots are all that we would want to commit to open trades at
any one time in this scenario.
The margin requirements may vary depending how the account is set up with the broker. Some
may offer 200:1 or even 400:1 but by increasing the leverage, exposure is also increased since
lower amounts of leverage are required per lot.
It is recommended that if available, at leverage option of least 100:1 is used, and a guideline of
using 5 x account balance is used to limit market exposure as this will mean you are better able
money management
to manage your open trades allowing for greater flexibility. This reduces the amount of risk that
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Table 6.6
Example 3:
money management
In this example, with a $5000 account, risking no more that 3%, the acceptable
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loss equals $150 dollars. As show in table 6.6, one mini-lot, $150 equates to 150
pips, at 3 mini-lots it equates to 50 pips.
If a possible trade entry is being considered and the acceptable stop for that
trade would be 75 pips, it will be necessary to adjust the lot size to be within
the parameters of the acceptable loss guidelines of $150. In that case, with this
example, only two lots would be appropriate.
Ideally, when holding multiple trade entries, ideally, no more than 6% total of account balance
should be risked at any time for all open trades.
Consider the following example of implementing a multi trade risk guideline:
Table 6.7
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Example 4:
In this example, risking 6% of $5000 for all open trades equates to a maximum of
$300 risk.
However, whether the risk being taken is 3% in a single trade or 6% on multiple trades, it is
important to remember that these would be considered maximum acceptable losses and
this does not mean that on every trade, every time, maximum risk or exposure should be used
whatever the trading context. To this end, each trade has unique characteristics and as a trader
it is necessary to determine if the maximum risk is appropriate on any particular trade.
Consider the following examples of implementing trade risk guidelines:
money management
Example 5:
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The purpose of this example is to establish the maximum number of lots that are
available to trade.
A mini-account has a balance of $10,000 and, following the guidelines of risking no more than
3% on any one trade, 3% of $10,000 gives a maximum single trade risk guideline of $300.
Based on the analysis of a pending trade, this trade will require a 50 pip stop. 50 pips is equal
to $50 per mini-lot since 1 pip is equal to $1. The $300 maximum risk divided by $50 mini- lots
gives 6 mini-lots.
Therefore, 6 mini-lots is the maximum number of lots that should be risked for this trade.
Example 6:
In this scenario the account balance is $8000 and of this, $400 dollar risk is
associated with open trades.
A new opportunity has been found that requires a 40 pip stop.
Using the guidelines of a maximum of 6% total risk at any one time, what would
be the maximum number of lots that could be traded on this new trade?
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With an account balance is $8000 and risk guidelines limit of 6% total trading
account over all trade, that gives $480 total risk available overall.
As $400 is already committed to open trades, that leaves $80 which can be
risked. A 40 pip stop equals to $40 per mini-lot at $1 per pip in a mini-lot. So $80
divided by $40 per mini-lot gives 2 mini-lots that are still available to risk on a
new trade opportunity.
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is worth exploring some trade scenarios to explore how they are implemented.
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A trade plan should include set guidelines for both appropriate leverage and sound risk
management. Appropriate leverage guidelines will limit the total exposure of trading account
to the market to five times the account balance. Sound risk management limits the risk that
can be placed on trades to 3% for any one trade or 6% for a total of all trades. This is the total $
amount of account margin that may risk being lost if the trade does not go as expected.
By having these guidelines in place, the chance that emotions will take control of trading is
reduced. It is important to apply these guidelines to each and every trade being considered.
The maximum risk should be used about as often as a car is driven at maximum speed which is
almost never. Remember less is more!
The following scenarios will use the account set up showing in the following table 6.8:
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Table 6.8
In table 6.8, the amount of volume controlled for each account type, the margin required or
the dollar amount gained or loss per pip is shown. Remember that these are nominal values for
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margin required and pip gain or loss and they may be different depending on the broker and the
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lots thus leaving some margin in reserve for any other trade opportunities that
may arise.
Example 8:
Trading in this example is on a standard account with a balance of $41000 and
no trades currently open. Analysis of the GDP USD chart indicates a potential
trade entry that, after assessment, would require an 80 pip stop. Using the stated
parameters and the exposure and risk guidelines developed above, which are the
same for any account type, determine trade feasibility and the number of lots
which you would commit to this trade.
The account balance is $41,000 and maximum exposure guidelines would limit a
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new trade to about 2 standard lots. Maximum risk guidelines would limit lots to
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be traded to about 1.5 standard lots. From these calculations, the risk guidelines
give a limit of a maximum of 1.5 standard lots to be traded. If the broker dealing
station allows for trades based on fractions of lots, the decision could be to enter
the trade with 1.5 standard lots. If not, 1 standard lot would be the maximum that
should be risked on this trade opportunity.
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Summary of Module 6
Forex trading is a business and the goal of any business is to make money.
To have a successful business trading business, it is important to have a business plan or a
trading plan in place to ensure that trade decisions and risk management are mechanical and
not based on emotional response to the market.
When shaping a personal trading plan, as with any successful business, the plan should be
written out, followed and evaluated as trading goes along. The trading plan should be revisited
from time to time to see trading goals are being met.
money management
A trading account should be sufficiently capitalized, if this is not possible at this time, it is better
to wait until it is before starting to trade
The trading plan should include sound risk management practices that take into account
maximum risk on a single trade or all open trades and maximum leverage to limit account
exposure.
Disciplined use of money management guidelines promotes success.
Adhering to a personal trading plan will increase the chances of success as a Forex trader.
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index
Index Of Sections
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Module 1
1.1
1.2
1.21
1.22
1.23
1.24
1.25
1.26
10
1.27
Keep it Simple
13
1.28
13
14
1.3
1.31 Consistency
14
1.32 Probability
15
1.33 Leverage
16
1.34
Risk Management
17
1.35
Setting Limits
18
1.36 Reality
19
Module 2
2.1
21
2.2
22
22
2.21
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2.22
23
2.23
23
2.24
24
2.25
A lot of math!
24
2.3
25
2.4
25
2.41
26
2.42
31
Module 3
3.1
36
3.2
37
3.21
37
3.22
41
44
3.31
45
3.32
49
53
3.41
54
3.42
59
3.3
index
3.4
106
3.5
Module 4
4.1
65
4.2
66
68
70
4.31
71
4.32
73
4.33
73
4.34
Trade Management
75
4.21
4.3
63
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Module 5
5.1
78
5.11
79
5.12
79
81
5.21
82
5.22
83
5.23
84
5.24
85
5.25
85
5.26
Trade Tactics
86
5.27
88
5.3
89
Module 6
6.1
91
6.11
Account Awareness
91
6.12
92
6.13
Stay Flexible
92
6.14
92
6.15
Evaluate Performance
92
Account Capitalization
93
6.21
Account Drawdown
94
6.22
95
6.23
95
95
index
5.2
107
6.2
6.3
6.31 Leverage
96
6.32
Risk Management
98
6.33
101
6.34
Important Reminders
103
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