Harriman House

Trading Sampler
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Introduction

Welcome to the Harriman House Trading Sampler.

In this free eBook, you will find a sample chapter from five of Harriman House’s
most recent and best trading books:
1. The Trading Playbook by Mike Gouvalaris
2. 7 Simple Strategies of Highly Effective Traders by Alpesh B. Patel and Paresh
H. Kiri
3. Tramline Trading by John Burford
4. Diary of a Currency Trader by Samuel J. Rae
5. Crowd Money by Eoin Treacy

When you wish to read on, all books are available to buy from the Harriman
House website, and all other good trading bookshops.
Remember that there is a free eBook edition with every print book purchase.
Enjoy the sample chapters!
Contents

Introduction / 3

The Trading Playbook by Mike Gouvalaris / 9

7 Simple Strategies of Highly Successful Traders

by Alpesh B. Patel and Paresh H. Kiri / 23

Tramline Trading by John Burford / 37

Diary of a Currency Trader by Samuel J. Rae / 61

Crowd Money by Eoin Treacy / 77

The Trading Playbook
by Mike Gouvalaris

The structure of a market day

There are three elements that make up each day in the market:
1. Day type
2. Gap type
3. Open type
Based upon these three elements, there are ten different combinations that make
up the trading playbook. The first element to look at is day type.

1. Day type
In order to define what day type we are seeing, we need to use the data from the
pit session or regular trading hours (RTH) only. The reason for this is that the
RTH session is generally when the most volume occurs.
As stated above, my trading principles can apply to any market with good trading
volumes and liquidity. The market I focus on is the E-mini S&P 500 futures
contracts (ES). So, in this case, the regular trading hours session would be from
the 9:30am EST open to the 4:15pm EST close.
There are three day types:

Up day
A trading day that concludes with the closing price ending higher than where it
opened at 9:30am EST. Figure 2 shows an example of an up day.
 Harriman House Trading Sampler / 10

Figure 2: Up day

Closing Price
1198.50

Open Price 1186.50

less than
Closing Price 1196.50
Open Price =
1186.50 Up Day Type

Down day
A trading day that concludes with the closing price ending lower than where it
opened at 9:30am EST. Figure 3 shows an example of a down day.

Figure 3: Down day

Open Price
1239.25 Open Price 1239.25
greater than
Closing Price 1199.75
=
Down Day Type

Closing Price
1199.75
 Harriman House Trading Sampler / 11

Neutral day
A trading day that concludes with the closing price ending equal to where it
opened at 9:30am EST. (This day type is rare – I will discuss how to deal with
this scenario in further detail later in the book.) Figure 4 shows an example of
a neutral day.

Figure 4: Neutral day

Open Price 1290.50

equal to
Closing Price 1290.50
=
Neutral Day Type

Closing Price
1290.50

Open Price
1290.50

It’s important to note that we are not concerned whether the market closed
positive or negative for the day. That is not what I am talking about when
referring to up days or down days. We are only concerned with how the market
closed in relation to its open.
For example, the market could gap up 1% on the previous day’s close, but close
up only 0.5% on the previous day’s close. In this case, the market closed lower
than where it opened the session. It resulted in a down day type, even though
the market as a whole closed in positive territory. This is a subtle yet distinct
aspect of my method.
Don’t worry, in the end I will put it all together so it makes sense. For now, I just
want to get you familiar with each of the concepts individually.
The next element that comprises the trading day is the gap type.
 Harriman House Trading Sampler / 12

2. Gap type
Like the day type, this concept is straightforward.
One of the features of the futures markets is their all-day tradability, as opposed
to stocks and options which only trade during the regular trading hours of the
market. The after-hours session is called the Globex or overnight session, and
the volume is generally much lighter.
This low volume is one of the reasons why my system doesn’t allow for any
trading during off hours – the market can be even more unpredictable during
these periods and I don’t see any statistical edge in placing trades at this time.
The six and a half hours during the regular trading hours session is more than
enough time to find some high probability opportunities.
During these off hours, economic news, macro headline events, global markets
and other factors can affect the futures markets, and cause them to open higher
or lower than where they settled the previous day. Where the market opens in
proportion to its prior day closing price is called the gap.
I will now describe the three gap types.

Gap up
When the 9:30am EST opening print is higher than the previous trading day’s
closing price. Figure 5 shows an example of a gap up.

Figure 5: Gap up

Open Price
1186.50

Open Price 1186.50

is higher than
Prior Close 1177.00
=
Gap Up Type

Closing Price
1177.00
 Harriman House Trading Sampler / 13

Gap down
When the 9:30am EST opening print is lower than the previous trading day’s
closing price. Figure 6 shows an example of a gap down.

Figure 6: Gap down

Open Price 1139.25

is lower than
Prior Close 1154.25
Previous Close =
1154.25 Gap Down Type

Open Price
1139.25

Unchanged gap
When the 9:30am EST opening print is equal to the previous day’s closing price.
(Like the neutral day type, a neutral gap type is rare. I will provide additional
notes on this later.) Figure 7 shows an unchanged gap.

Figure 7: Unchanged gap

Previous Close Open Price

1293.00 1293.00

Open Price 1293.00

is equal to
Prior Close 1293.00
=
Neutral Gap Type
 Harriman House Trading Sampler / 14

3. Open type
The last element of the trading day is the open type. An open type essentially
means where the market opened compared to the previous trading day (also
referred to as the trading session).
There are a couple of simple concepts to understand as part of the way I look at
the open type.
The first concept is the range. We are going to think in terms of the entire trading
range for the previous day. So if the ES traded with a low of 1900 and a high of
1910, the entire trading range for that day would be 1900-1910.
The next concept is the previous day’s open price; this is where the actual pit session
for the previous day began trading. Some market profilers look at the first swing
high to low off the open on a 1 minute or tick chart. Personally, I tend to keep
it simple and look at the open price for the very first price bar at 9:30am EST
on that day.
So, bearing in mind these concepts, let’s now look at the four basic open types.

Above range/above previous day’s open

When the market opens above the previous trading day’s high, and also above
the previous day’s open price. An example is shown in Figure 8.

Figure 8: Above range/above previous day’s open

Current Day:
Open: 1955.50
Equals an Above Open/Above Range open type

Previous Day:
Open: 1950.50
High: 1952.25
Low: 1944.00
 Harriman House Trading Sampler / 15

In range/above previous day’s open

When the market opens inside the previous day’s trading range, and also above
the previous day’s open price. An example is shown in Figure 9.

Figure 9: In range/above previous day’s open

Previous Day:
Open: 1925.50
High: 1933.50
Low: 1922.75

Current Day:
Open: 1927.00
In Range/Above Open of the prior day

In range/below previous day’s open

When the market opens inside the previous day’s trading range and below the
previous day’s open. An example is shown in Figure 10.

Figure 10: In range/below previous day’s open

Previous Day:
Open: 1845.75
High: 1863.00
Low: 1813.00

Current Day:
Open: 1824.75
Inside Range/Below Open of the prior day
 Harriman House Trading Sampler / 16

Below range/below previous day’s open

When the market opens below the previous trading day’s low of the day, and
also below the open price of the previous trading day. An example is shown in
Figure 11.

Figure 11: Below range/below previous day’s open

Previous Day:
High: 1892.75
Low: 1865.00

Current Day:
Open: 1845.75
Below Range/Below Open of the prior day

When we identify open types, it will become very important to be aware of the
midpoint of the prior trading day. This will come into play in determining the
probable outcomes, as I will discuss in greater detail later.
Most charting packages come with a Fibonacci retracement tool. You can easily
find the midpoint of the trading day by selecting the high and dragging it down
to the low (or vice versa) to calculate the 50% line. Another way to calculate the
midpoint is to add the high of the day to the low of the day and divide by two.
An example of finding the midpoint using the Fibonacci retracement tool is
given in Figure 12.
 Harriman House Trading Sampler / 17

Figure 12: Using the Fibonacci retracement tool to find the midpoint of the
trading day

Use Fibonacci Tool to measure from high to

low (or vice versa) to figure the midpoint

Trading day situations

Now that we have an understanding of the different day types, gap types and
open types, we can put all of this together so that we are prepared for whatever
the market throws our way.
Every trading day will have one day type, one gap type and one open type.
When these features are combined it gives a clear picture of the potential for
either trend continuation or trend reversal. It also gives an idea of what days it
may be acceptable to fade the market, like on rotational days looking for gap
fills, and what days it may be best to trade with the trend and not attempt to
fade at all.
An example of using the three pieces of information together is as follows:
• Previous day type: Up day
• Gap type: Up
• Open type: In range/above previous day’s open
I will now work through a list of probabilities for each of the ten different market
day scenarios. I will also gauge the conviction level of the short-term trend in
each scenario. You will see that all possible situations are covered within the ten
 Harriman House Trading Sampler / 18

day setups. When you know which of the ten setups reflects the current market
session, this enables you to make conclusions about the price action for that day.
After that, we will look at a recent example of each of the ten different scenarios
using a 15 minute price chart of the E-mini S&P 500 futures contracts. We will go
through the price action and see how each day could have been traded according
to the playbook.
There is a summary of the ten day setups in the following table.
Note: Gap fill statistics for each setup are taken from the MastertheGap.com.

Ten day setups

Day Previous Gap fill

Gap type Open type
setup day type probability (%)

1 Up Up Above range 65

Inside range/above open

2 Up Up 85
(previous day)

Inside range/above open

3 Up Down 74
(previous day)

Inside range/below open

4 Up Down 65
(previous day)

5 Up Down Below range 48

6 Down Up Above range 54

Inside range/above open

7 Down Up 61
(previous day)

Inside range/below open

8 Down Up 74
(previous day)

Inside range/below open

9 Down Down 83
(previous day)

10 Down Down Below range 64

 Read on...

The Trading Playbook

Two rule-based plans for day
trading and swing trading
By Mike Gouvalaris
Traders have a tendency to over-complicate. Many search for the latest
new indicator that will give them an edge, or a new trading strategy to
deliver bigger wins. The message of The Trading Playbook is to forget
all of this and concentrate on three solid foundations to improve your
trading performance: simplicity, probabilities and hard work.

Available as paperback and eBook. Free eBook with paperback purchase.

www.harriman-house.com/tradingplaybook
7 Simple Strategies of Highly Successful
Traders
by Alpesh B. Patel and Paresh H. Kiri

Stategy 4: Mean Reversion

Introduction
The essence of our fourth trading strategy is that prices have a tendency to go
back to where they have been in the recent past. The principle is known as mean-
reverting – it implies that 90% of the time the price will not move in any trend
but just back and forth around a set point for a period of time.
This strategy is used by professionals and novices alike so it should be simple
enough for any trader to apply.

Strategy basics
The principle of mean reversion
Figure 4.1 depicts the essential concept of mean reversion, which is that there
is an area of value around which a price will oscillate. We can see that 70% of
trades take place in the area around the mean price. Knowing this allows us to
take advantage of the fact in our trading.
 Harriman House Trading Sampler / 24

Figure 4.1: the principle of mean reversion

Strategy rules
The essential rules of the strategy are as follows:
Entry
• Draw by estimate a mean reversion line.
• Go long as price falls (or vice versa).
• Start with a small $1 per point profit or loss. For example, if GBP/USD rate
moves 0.0001 you should make $1. Build trade size so that any exit at a loss
is 2% of your total trading capital.
Exit
• If price hits the mean reversion line or your stop loss.
We will elaborate more on these rules as we work through the examples below.

Drawing the mean reversion line on the chart

Let’s take a look at Figure 4.2, showing GBP/USD. This is a three-minute chart,
so each individual bar represents three minutes of price moves. (We could quite
easily have chosen a five minute or a 30 minute chart.) These charts are available
 Harriman House Trading Sampler / 25

from all the main providers of online platforms like Capital Spreads or ETX,
who provide charting free as part of their brokerage services.
Drawn on the chart is a horizontal line at the price of 1.551, which is the best
guestimate of the average or mean around which the price is moving. Price is
seemingly reverting to this mean and if it gets too far away from it we would
expect it to move back towards it again.
Some software will draw this line for you under what’s called a ‘linear regression’ –
this is a statistician’s way of saying the average price over a period of time, or line
of best fit. In a fast trading environment we can draw our own linear regression
line, saving time to get on with the activity of trading.
For each different time frame the mean would of course be different and thereby
so would our trades. An example is also shown below for daily charts (see Figure
4.3).

Figure 4.2: GBP/USD three-minute chart

So who uses the three-minute chart?

Someone who is trading actively during the day. They may even trade on the
one-minute chart. They do this because it gives them lots of trading setups and
allows them to deploy their capital and earn a return on this capital.
 Harriman House Trading Sampler / 26

Figure 4.3 is a daily chart for GBP/USD, where each bar represents the high,
low, open and close for the day (i.e. the day’s range). The average or mean comes
in at around 1.58. Again the idea is that if the price extends too far away from
this, either above or below, then we can expect the market to tend to come back
towards 1.58.

Figure 4.3: GBP/USD daily chart

The question you will be asking is, does the price revert to the mean often enough
to profit from it?
In short, yes. But given that if it didn’t we could be stuck in a trade waiting for it
to come back to its mean price we must put in stop losses to protect our capital.
This strategy developed because predicting trends intraday is not the best use of
time. Traders want to have a better idea of where the price is heading based on
where it has been, not where it might go based on where it has never been. This
enables them to be actively trading, making the most of short-term intraday
opportunities that emerge.
Two more examples
 Harriman House Trading Sampler / 27

Below are two more illustrations. Figure 4.4 is another example of a daily reversion
mean opportunity in EUR/USD. It shows 1.37 as an area around which the price
seems to be mean reverting.

Figure 4.4: GBP/USD daily chart showing 1.37 as a mean reversion area

Figure 4.5 shows an example where GBP/USD does not revert to the mean over
the period February 2014 to May 2014. If we had expected the price to return
to the region of 1.64 we would have waited a long time and potentially suffered
a large loss.

Figure 4.5: GBP/USD showing no mean reversion on the daily chart from
February 2014 to May 2014

Every now and then the market will move away from the most recent range that
forms the basis of this strategy. As long as we have our stops in place then we
will be out of the trade and ready to participate the next time the market begins
its mean reversion.
 Harriman House Trading Sampler / 28

The strategy in practice

Mean reversions are excellent for day trading and certainly most charting packages
will have some kind of oscillator for you to define the most likely mean reversion
point in any given time frame. We shall explain the methodology using Figure
4.6, a three-minute chart for GBP/USD.
Here the mean reversion line is at 1.5525. Our entry is at point ‘A’ at 1.5500. Point
B is the worst price reached while we are in the trade and point ‘C’ is where we
get out, at 1.5525. We will explore this trade in more detail below.

Figure 4.6: GBP/USD three-minute chart

Planning your trade according to your psychology

1. Choose your time frame. If you intend to be a day trader, sitting in front
of the computer, then a three-minute or five-minute chart would be more
than adequate. If instead you are trading part-time, then a daily chart may
be better, where each bar is the range for the whole day.
 Harriman House Trading Sampler / 29

2. Choose a mean reversion line. We need sufficient data points upon which to
form a mean around which price oscillates. Only then can we choose a mean
reversion line. In Figure 4.6 we have marked where we believe the mean is
using a horizontal line. Over 100 historical bars are covered by this line. This
clearly shows that for quite a while the price has been moving around this
mean of 1.5525 and the assumption can be made that the price will continue
to do so. This can be estimated by eye when you look at the chart, which
is how most day traders will do it. Most trading platforms with charting
facilities will allow you to add a linear regression line between a historic
point and today’s price.
3. Choose an entry point. At which price do we trigger a trade? Going back
to Figure 4.6, let us consider point ‘A’ that represents a point where price
had moved too far from this mean and will revert back to it. We could have
picked this point using complicated statistical measures such as standard
deviations, but let’s keep it simple. Our entry is 1.5500 because:
• It looks like a level which the price tends not to reach frequently.
• It’s far from the mean and so likely to result in a good opportunity to
make a profit.
• It’s not so far from the mean that it is the start of a whole new trend.
• If the price is at a round number then most likely we will see some support
or resistance around this point intraday.
So, to recap, the entry is 1.5500 and the mean reversion line is at 1.5525. We are
looking to exit when price gets back to the mean reversion line at around point
‘C’.

Profit targets and stop losses

So how much can I make from this trade?
Well, if I made $1 for every point from entry to exit at the mean reversion line,
then I would make $25 (1.5525 - 1.5500). Of course you can trade multiples of
that, depending on how much trading capital you have, but more on that in a
moment.
Prices will never move in a straight line and it may take time to get to our target.
Given that the price in one trade can take several hours to reach our target, we
should be prepared to trade on multiple currencies and commodities, having
placed multiple positions in varying time frames.
This diversifies risk, assuming they are not all the same time frame of three
minutes and all USD trades. Even then, you would want to be non-correlated,
 Harriman House Trading Sampler / 30

i.e. your trades should not all be moving in tandem, which will prevent you from
exposing your capital to a singular large risk.
Point ‘B’ represented our worst moment in this trade when the price went as low
as 1.5485. At that point we were sitting on a paper loss of 1.5500 - 1.5485 = $15.
How did we know not to exit at that point? Or put another way, what is our stop
loss, the point at which we exit with a loss? We cannot hold on forever taking an
endless loss all in the hope of making $25.
If the stop loss is equal to the profit to be achieved, i.e. $25, then that is a good
measure.
You may have spotted that if we win $25 when we win and lose $25 when we
lose, we don’t make any money. This is true – in fact, after brokerage costs, we
would be losing a little. However, this is where the principle of mean reversion
comes in. If we expect prices that have fallen quite far to rebound to the mean
as if on a bungee rope, then we expect to win more often (i.e. prices extended
from the mean revert back to it) than lose (i.e. prices go on extending and make
ever greater losses and do not mean revert).
So imagine we were therefore expecting to be right – the price reverts back to
mean – six times out of ten, and wrong four times out of ten.
Then our results would look like this:
• Profits = 6 x $25 = $150
• Losses = 4 x $25 = $100
• Overall profit per ten trades = $50.

The risk of placing larger trades

It looks like we have just found a profit-making machine. If so, why would we
just not make bigger bets, such as ten times the size? The answer is, what if we
have a string of losses? Imagine we placed trades 100 times larger and we had
five losing trades in a row. We would be down 5 x $2,500, that is $12,500. If your
total trading capital was $12,500 then you would be wiped out.
Okay, but suppose your trading capital is not merely $12,500. How do you then
decide how much to bet in each trade to maximise your return? After all you don’t
want to make a pathetic $25 now that you’ve discovered a profit-making strategy.
As mentioned, you should lose no more than 2% of your trading capital when
you are wrong. If you have $12,500 then that means you should lose no more
than $250 when you are wrong on any one trade.
 Harriman House Trading Sampler / 31

Using the same pattern of wins and losses for every ten trades as in the example
above, that would mean you would have six $250 winning trades, making you
$1,500, and four $250 losing trades, losing you $1000. Overall for every ten trades
you would make $500 profit.

Further thoughts on mean reversion

The key to executing this strategy successfully is in how well you exercise
discipline. Stick to your trading plan and do not get too greedy or too confident.
You may consider entering the trade at closer to the mean reversion line as,
after all, the price will revert. It is true you could do this, setting your stop loss
proportionately. But you will potentially make less money, because the move
back to the mean is small from a closer entry point.
Okay, you ask, why then not increase the bet size and trade from a closer distance?
There is nothing wrong with that, as long as you stick to your stop loss. The
problem is that the price could just keep hitting your stop loss, i.e. continuing
to move away from the mean reversion line. The point of us picking point ‘A’ in
the example above was that the price was unlikely to go beyond that based on
recent price action.
Imagine an elastic band – the more you stretch it, the faster and more power it
possesses to revert to a balanced state. Trade too early and you risk being stopped
out too often; trade too late and you may be on the wrong side of a new trade
and a new mean being sought by the market.
Another thing you may consider is entering closer to the mean reversion line and
putting your stop loss a lot further out. The answer is that you could do this as
long as [number of winning trades] x [$profit per winning trade] is greater than
[number of losing trades] x [$loss per losing trade].
So imagine you entered if the price moved $10 away from the mean reversion line
and your stop loss was $100 away. That is if you suffered a $100 loss you would
exit. This is fine as long as you had ten winning trades for every losing one.
Let us have a look at Figure 4.7, which is another GBP/USD daily chart. You
place a stop loss very far away. You then just keep entering trades as you see fit as
soon as they move from the mean reversion line. What could go wrong?
Well, as mentioned, you could have a string of losses and wipe out your account.
This could happen if you opened all the positions indicated in Figure 4.7 with
the label ‘Entry Points’ and your stop loss was hit each time.
 Harriman House Trading Sampler / 32

We avoid that by following the rules of limiting our bet size and making sure
that if we have a string of, say, five consecutive losing trades then we do not come
even close to wiping ourselves out. In fact, five consecutive losing trades should
lose no more than a total of 10% of our total trading capital.

Figure 4.7: GBP/USD daily price chart

Conclusion
Presented below are actual trading results from applying this strategy. Figure
4.8 shows 454 trades placed in the first two weeks of July 2008. 450 trades won.
Each horizontal line shows the level of profit per trade. The profit is not exactly
equal for each trade because this represents all trades, across all time frames and
all products, using this strategy.

Figure 4.8: results from trading the mean reversion strategy

 Read on...

7 Simple Strategies of
Highly Effective Traders
Winning technical analysis strategies that
you can put into practice right now
By Alpesh B. Patel and Paresh H. Kiri
In 7 Simple Strategies of Highly Effective Traders, Alpesh Patel and Paresh
Kiri provide a practical guide to seven technical analysis trading approaches
that are simple, effective and easy to put into practice. These are the
kind of strategies professional traders use to manage their trading.

Available as paperback and eBook. Free eBook with paperback purchase.

www.harriman-house.com/highlyeffectivetraders
Tramline Trading
by John Burford

My Charting Methods
In this chapter I will review one of the basic concepts I use in my charting and
explain how I use it with my favourite chart patterns to uncover great trade
setups. This concept is:
1. Support and resistance

1.1 Support and resistance

Support and resistance levels can help you identify good entry and exit points. If
a market is declining into a solid support zone, the odds are good for a bounce
of some sort; or if a market is rallying into overhead resistance, odds for a turn
are high. And noting where the support/resistance levels are located can give you
added confidence in a trade that you have identified by other methods.
Because support and resistance zones are derived from previous price action, it
is clear that markets have memories. Markets remember the price levels where
traders have previously established their positions and current price patterns are
influenced by them. I will explain how this works in this chapter.
I use four different types of support/resistance levels:
1. horizontal support/resistance levels in congestion zones
2. trendlines (sloping lines of support/resistance)
3. Fibonacci retraces
4. chart support/resistance
We will now look at these in detail.
 Harriman House Trading Sampler / 38

1. Horizontal support/resistance levels

The horizontal support/resistance zone is one of the most basic of charting
patterns. One major feature of these levels is that a support line transforms into
a line of resistance after the market has penetrated the support (and vice versa).
Figure 1.1.1 is a great example of support/resistance areas in gold.

Figure 1.1.1

This is the 15-min gold chart and the resistance level of $1238 is clearly visible
with several high touch points between 14 and 16 December. Then, the attempt
to break up through the resistance on 16 December was successful with many
buy-stop orders being triggered. Many chartists note these resistance levels and
place their protective buy stops just above this level. These are the buy-stops of
the shorts that are hit when the resistance is overcome. There are also entry buy-
stops placed there by those traders looking to be long on such an upward break.
After those buy orders were filled the market fell back in a normal re-test and
the resistance zone then became a support zone.
On 17 December, the market fell back to test the new support zone. This held
and the market proceeded to test the resistance zone. This zone was created by
the lows at the $1240 level. When those lows were broken, sell stop-losses were
 Harriman House Trading Sampler / 39

touched. So now, the market is trading between a narrow support and a resistance
zone and will break out of it in due course.
So what were the internal dynamics of the market in this period and why does
a resistance line turn into a line of support?
I will start with the idea that the current market price is determined by only a
small number of traders. It takes only one buyer and one seller to make a price.
When you have taken a position either long or short, you have no more influence
on the price until you decide to trade again.
So, because short-term players will be trading much more frequently than
position traders, these short-term traders determine the short-term price patterns.
Many will be trading several times a day. Because these traders are shooting for
relatively modest gains per trade, they also limit losses on losing trades.
Let’s take a trader who noted the initial resistance at $1238 and decided to short
the market when it reached that level again. With the breaking of this resistance
on 16 December, that trade is a loser. When the trader sees the market get away
from him as it rallies to $1250, he knows he has a losing trade and will naturally
seek to exit his trade if the market gets back to near his entry, thus enabling a
smaller loss.
In addition, there will be traders who look to go long on a decline to the $1240
support and this will compound the buying pressure.
That is why, when the market retreated to the $1240 level, many shorts are covered
and new longs initiated, thereby providing buying support. Similarly, when the
market broke the $1240 support, it got back to the $1238 area and more buying
emerged by the shorts who had a losing trade previously. Figure 1.1.2 shows how
that played out.
 Harriman House Trading Sampler / 40

Figure 1.1.2

The resistance at the $1240 level was strong enough to turn the budding rally back
on 17 December. And then the $1238 support level was breached. The market
then fell under sustained selling by the disappointed bulls. The bears had won.
A short trade could be made on the break of the support low in the $1236 area
because with the break, the previous support line now becomes resistance. Any
rallies should be contained by this resistance in the $1238 area. This enables a
protective stop to be entered just above this level for a low-risk trade.
I have just described a short-term support and resistance setup with horizontal
zones. We can also find horizontal support and resistance zones in longer-term
charts.
Figure 1.1.3 shows the weekly FTSE 100. The top bar in this chart is a seven-year
resistance zone, and the bottom zone is both resistance and support (at various
times). The most recent decline in June 2013 was contained by the seven-year
support zone, and the most recent highs are being contained by the seven-year
resistance zone.
I hope you find this an impressive demonstration that markets have long
memories. It is a theme I will keep coming back to. The 6,000 and 6,800 areas
are very important for the FTSE 100, which means that if the market gets back
to either of these levels, it will be well worth noting for a possible long-term
trade setup.
 Harriman House Trading Sampler / 41

Figure 1.1.3

2. Trendlines (sloping support/resistance)

The trendline is another very basic element of charting. It is the basis of my
tramline method, which I cover in detail in Section 2.1.
If we consider a bull market, the price pattern is a series of moves up and down
but travelling generally in an upwards direction with higher highs and higher
lows.
It is a curious fact that often the lows of these waves can be connected by drawing
a straight line between them. Why this phenomenon exists is a mystery and most
of us take it for granted.
An example is shown in Figure 1.1.4.
 Harriman House Trading Sampler / 42

Figure 1.1.4

There were the two major lows in 2012 and I have drawn a straight line between
them and extended it. This is a line of support in a bull market. Months later in
June the market made a major low right on the line and then resumed its uptrend.
The market had remembered the previous lows and bounced off this line of major
support, which was set on the chart months previously.
But not all trendlines have such accurate touch points.
How do I find the best fit for a trendline?
To help answer this, I will briefly explain why I prefer candlestick charts to bar
charts.
The reason for this relates to candlesticks containing what I call pigtails – the
thin lines above and beneath the solid body of the candlestick.
Figure 1.1.5 will help me to describe what I mean.
 Harriman House Trading Sampler / 43

Figure 1.1.5

On the 10:00 am candlestick, the bottom of the body is the opening price for
that hour and the top of the body is the closing price for that hour. The low of
the pigtail is the lowest price in that hour. This pigtail may have been a spiky
move – a quick down and then up as stops are hit and the dip is supported. For
me, the most important section of trading is between the opening and closing
prices – in other words, the thick body of the candle. And this section is most
readily visible on a candlestick.
For this reason, I sometimes (but not always) crop off the pigtails when I look
for trendlines.
A great example is shown in Figure 1.1.6. Here, I crop the upper pigtail where
marked because my line makes a better fit on the lower touch point and I now
have three touch points (the more touch points the better). My job in trendline
placement is to make the best fit for the available highs or lows.
Does it matter how precisely you draw the trendline?
The answer is: it all depends. If you are looking for a reversal from a down-sloping
trendline, you would be placing your entry buy stop just above the trendline,
hoping to catch a sharp rally taking the market through your stop. In the above
example, being too accurate was not necessary because the rally was sharp.
 Harriman House Trading Sampler / 44

However, if you are looking to trade with the trend and enter the market at or
very close to the trendline, being accurate in trendline placement is necessary
when seeking a low-risk trade. I shall show some examples in the next section.

Figure 1.1.6

Now, back to looking for trendlines.

When starting to look for a trendline I always start with the top (or bottom) tick
and swivel my line until I can visually line up at least one other accurate touch
point. If I have more than one accurate touch point, then I can usually say that
I have my best fit.
But, if not, then I must compromise even if it means cutting off pigtails.
In the example shown in Figure 1.1.7 I have two alternative trendlines. The line
starting at the extreme high on 30 November cuts off pigtails on 10 December
but includes the latest high as an accurate touch point. That is good.
The other line cuts off the pigtail on the 30 November high and includes the
accurate touch point on 10 December, but misses by a wide margin the latest
highs. If you were trying to line up a short trade near this line, you may have
missed an opportunity.
 Harriman House Trading Sampler / 45

Figure 1.1.7

Sadly, there is no easy answer to the question of trendline placement when

the absolute highs (or lows) do not exactly line up. But when we examine the
equivalent tramline placement, it often clears up this question. Which trendline
ought to be drawn on the chart in Figure 1.1.7 is cleared up using tramline
placement in Section 2.2.
Figure 1.1.8 provides a great example in gold (which is a market notorious for
pigtails).
There are several options for the upper tramline placement in Figure 1.1.8. So
I start with the lower tramline instead. And here, I have an accurate tramline
complete with a pigtail cut-off. There really is no other way to place this tramline.
It has two accurate touch points and a pigtail cut-off.
With this tramline now fixed, I can then draw in the upper parallel tramline as
shown. Previously, the upper tramline had options, but with the lower tramline
in place, the upper line is now set. It starts from the absolute high at the top,
left-hand arrow (in fact, it is a double touch point) and there are two other
widely-spaced accurate touch points.
The second upper arrow points to an overshoot. Overshoots do not necessarily
invalidate a trendline, but if there are more than two big ones, I would not use
 Harriman House Trading Sampler / 46

that trendline. The line has four touch points, making this tramline a secure line
of resistance.
It is quite rare – and reassuring when it does happen – to find more than three
or four touch points lining up accurately on a trendline. You must allow some
leeway.

Figure 1.1.8

Using a pair of parallel tramlines in this way enables me to place both lines
accurately. I will discuss this in more detail in Section 2.2.

Trendline fitting
The rule I adhere to is this: the more accurate the fit, the more confidence I can
have in the tramline (or tramlines) as a reliable line of support/resistance.

3. Fibonacci levels as potential support/resistance

The Fibonacci tool on your charting package is one of the most important in
your toolbox. I use the Fibonacci levels to anticipate market turns. They can be
 Harriman House Trading Sampler / 47

remarkably accurate, enabling you to enter tight protective stops for a low-risk
trade, provided this is indicated from additional analysis.
The only decision you have to make is from which pivot points to draw the
Fibonacci levels. By pivot point, I mean the high and the low that are chosen to
divide into the various Fibonacci levels.
How can I find the best pivot points?
I have found that the pivot points that usually work best are the most recent
significant high and low. But these may not always get the best results. You see,
we are looking for the best fit of the lines to the highs and lows between the pivot
points. Sometimes this is obtained when the second significant high/low is used.
To start the search for the best fit, I always go for the most recent high and low
as my pivot points to test my Fibonacci levels. Figure 1.1.9 helps to show what
I mean.

Figure 1.1.9

Here, I have used the major high and low as pivot points and right away I see
that the two major intervening highs are made at the Fibonacci 62% and 50%
levels (indicated with the first two arrows as you read from the left). This occurs
before the low pivot point is put in. Then, on the rally, the market was turned at
 Harriman House Trading Sampler / 48

the Fibonacci 62% level (most right-hand arrow). The fact that the market made
those accurate hits (left-hand arrows) previously increased my confidence that
the subsequent rally would likely turn at a Fibonacci level.
Does using the extreme high/low always give the best fit?
Sometimes, using the extreme high or low for pivot points does not give you the
best fit. By this I mean none of the intermediate highs/lows lying between the
pivot points do not lie easily on the various Fibonacci levels. To make a best fit,
I need to see at least one major high/low accurately touch a Fibonacci level. An
example is shown in Figure 1.1.10.

Figure 1.1.10

Here, I have used the second major low as pivot point (pp) and note the accurate
hits on the Fibonacci 62%, 50% and 38% levels on the way up to the high pivot
point (these hits are marked with the first four arrows as you read from the left).
And to confirm this choice, following the high the market declined to an exact
hit on the Fibonacci 38% support level (marked by the most right-hand arrow).
That was a low-risk trade entry level.
Note that I had four earlier arrows and four accurate hits. Having four hits gives
me great confidence I have selected the correct pivot points.
My rule of checking the second pivot point as well as the major high/low only
applies to the earliest pivot point, not the latest one. In fact, this second high/low
 Harriman House Trading Sampler / 49

is often a wave 2 (w2) in a five-wave sequence (see Section 3.8 for Elliott Wave
analysis). As it happens, in the above example the rally is not a clear five-wave
impulse pattern.
I will always check these alternative pivot points in this way for my best fit.
In general, the more accurate the hits are by the intermediate highs/lows, the
more confidence I will have that I have my best fit. Of course, if the market has
made an accurate hit on a shallow Fibonacci level after the most recent pivot
point has been made, and the market then digs deeper into the retracement,
the approaching Fibonacci levels will give me high confidence that turns will be
made at one of them.

4. Chart support/resistance
In traditional charting, a congestion zone is an extended period of trading which
takes place in a relatively narrow range of prices. The market swings up into
resistance and then down into support and then up again with no clear direction.
This can drive you mad if you are trading breakouts and you can be whipsawed
to death on the false breakouts.
Congestions zones are very common in charts in all time scales. They represent
a kind of equilibrium between the bulls and the bears with neither having an
upper hand in that period.
What typically occurs when the market breaks out of a congestion zone?
When the market does manage to break away from a congestion zone and
approaches it again, the market is often turned away from the edge of the zone.
In other words, the outer limits of the congestion zone act as support/resistance,
whereas before it was resistance/support.
An example is shown in Figure 1.1.11.
 Harriman House Trading Sampler / 50

Figure 1.1.11

The congestion zone is highlighted. Within the zone, every time the market
approached the lower and higher limit, it was turned back. These limits acted as
support and resistance. Then the market broke up out of the zone. When it tried
to fall back into it, it hit support at the upper limit. The market then climbed
away, but when it declined off the 1.38 level, it hit support again at the upper
congestion zone level.
This support level was previously resistance when the market was trading inside
the zone. I call this chart support and it is another result of the market having
a memory.
Figure 1.1.12 shows another example where there is a small false breakout of the
congestion zone, which has broken to the downside. Now, the market is trying
to rally back and has hit the underside of the zone. This level is now resistance
where previously it was support.
 Harriman House Trading Sampler / 51

Figure 1.1.12

With no other knowledge, a short trade here might seem a good trade as the
market had rallied into resistance and the next move should be down.
So, was this an advisable trade?
To answer that question we must always consider the context of the trade in
question (see Section 3.9). Analysing the Elliott Waves (EW) from the top, my
wave labels are shown in Figure 1.1.13.
Before the break of chart support, I can count waves 1, 2, 3, and 4. Wave 3 is
strong to the downside (the strongest (lowest) momentum reading occurs within
this wave, which is a guideline of Elliott Wave Theory) and there is a budding
positive momentum divergence at my wave 5 low, confirming that a turn up is
very likely.
 Harriman House Trading Sampler / 52

Figure 1.1.13

With this knowledge, you should be expecting at least some upward retracement
of the decline off the w5 low; thus the suggested short trade was not advisable
because fifth waves are ending waves. Of course, before the w5 low was made,
I had no evidence there would be a momentum divergence, but since I could
count four waves and infer the fifth lay just ahead, I could give this trade a pass.
Another great example of what I mean by understanding context is shown in the
Tesco chart in Figure 1.1.14.
Tesco has rallied and has entered a definite congestion zone of trading with the
price confined between the two support and resistance bars on this daily chart.
And now it has broken up out of congestion.
Is this a good long trade signal?
Once again, I always look for context at any possible Elliott Wave count within
the current wave. My normal routine is to start at the low and work upwards in
a bull trend (opposite for a bear trend). I can count perhaps waves 1 and 2 and
the long and strong wave has all the hallmarks of a third wave (see Figure 1.1.15).
In fact, whenever I see a long and strong move, I always suspect I have a third
wave. That is my starting point on many charts.

Figure 1.1.14
 Harriman House Trading Sampler / 53

If I have the first three waves labelled correctly and the last touch on the support
line is my wave 4, then the breakout could well be a fifth (and ending) wave. I
do not want to be trading long into a fifth and final wave up! And sure enough,
my suspicions were confirmed that the wave 5 breakout was a false buy signal,
as you can see in Figure 1.1.15.
So, I have a complete five waves up and the next move is down. This Elliott
Wave interpretation was aided by the large negative momentum divergence on
the breakout. In fact, the wave 5 breakout was a sell signal, since fifth waves are
best traded by fading them.
If I had gone long on the upside breakout in wave 5, I would be nursing a heavy
loss on the gap down.
This is an excellent example of how, by reading the relevant Elliott Waves, you
can avoid common pitfalls.
 Harriman House Trading Sampler / 54

Figure 1.1.15

Another great example of reading Elliott Waves to inform your trading decisions
can be seen in the very long-term chart of AUD/JPY in Figure 1.1.16.

Figure 1.1.16
 Harriman House Trading Sampler / 55

From the 2008 low, the market rallied and entered a multi-year congestion zone
which has very precise support and resistance levels. The congestion zone is a
wide one of over 1000 pips and offered multiple opportunities for swing traders.
The zone was formed from the resistance level provided by the low in early 2008
and the support just above the 70 area.
But in early 2013, the market managed to make a break up from the zone.
We must always ask the question: is this a genuine break or a false move?
A genuine break would involve a major new bull run – preferably in a third wave
– to above the highs of 2007/8. A false breakout would infer a decline back to
support and perhaps the start of a new bear run.
At this upward break, the Elliott Wave labels are clear and the breakout is a fifth
wave into 2013. That is not to say a long trade was inadvisable. On this scale, the
rally carried by over 1000 pips in a few months – a very substantial move for a
swing trade.
Then the market topped out in the 105 area and dropped back towards the
congestion zone, but found good support when it hit the extension of the
previous resistance level from the congestion zone. This is a textbook example of a
long-term resistance level transforming into support after its upward penetration.
That was a good area to look for a new long trade. The downside risk was low
because of the strong support.
Finally, Figure 1.1.17 is a chart showing the congestion zone as a continuation
pattern.
 Harriman House Trading Sampler / 56

Figure 1.1.17

Here is the context: I am unable to place Elliott Wave labels on the decline and
to me, it is clear this zone is not a wave 3/wave 4 combination as in the above
examples. This allows the possibility to take a short trade on a break of support
with confidence, since the trade would be trading with the trend (down).

Summary
1. I look for four types of support/resistance:
i. Horizontal
ii. Sloping (trendlines and tramlines)
iii. Fibonacci levels
iv. Chart support/resistance in congestion zones
2. Markets have memories – that is why the notion of support and resistance
occurs. Be watchful when the market is entering an old area of support/
resistance.
3. Always judge the context of the pattern within waves, especially if the Elliott
Waves can be readily discerned.
4. Watch for false breakouts, especially if in the fifth wave position. You can
 Harriman House Trading Sampler / 57

look to fade these. This applies especially when dealing with chart congestion
zones.
5. I n general, when the market is descending into a support zone, look to trade
long. And when it is ascending into a resistance zone, look to trade short.
But try to find other reasons for the trade from tramlines or Elliott Wave
analysis.
6. A
lways apply the Fibonacci levels when you have a major high and low in
place. These will give you the most likely turning points for any counter-
trend move, and the 50% and 62% levels are the most common. Try for a
best fit with the second major high/low as the earliest pivot point. This may
make the intervening highs/lows lie more accurately on the various Fibonacci
levels. When several minor intervening highs/lows lie on the Fibonacci levels,
you can have high confidence in them as future support/resistance levels.
 Read on...

Tramline Trading
A practical guide to swing trading with
tramlines, Elliott Waves and Fibonacci levels
By John Burford
There are certain universal chart patterns that are traced out time and
time again by markets - these patterns have stood the test of time and
can be instantly recognised by a skilled trader. When you learn how
to spot these patterns and use them to forecast market action you
have the basis of a winning trading method. Tramline Trading is a
complete practical guide that shows you precisely how to do this.

Available as paperback and eBook. Free eBook with paperback purchase.

www.harriman-house.com/tramlinetrading
Diary of a Currency Trader
by Samuel J. Rae

My trading plan
There are four components to my trading plan, which I will describe in turn here:
1. Charts
2. Candlesticks
3. Historic price levels
4. Timing

1. Charts
When explaining how I trade, the natural starting point is my use of charts. As
I have mentioned, charts are a graphical representation of historical price data.
This graphical representation makes it much easier to locate points at which there
has previously been price contention and it can also offer an indication of the
direction in which a market is heading and the strength associated with future
moves. Charting can be extremely useful – indeed I would not be able to trade
the way I do without it – but you must be very careful in your interpretation of
charts in order to benefit from them.

Time frame
One key characteristic of a chart is its time frame. That is whether the chart
represents months, weeks, days, hours or minutes of price action data.
My preference is to use daily charts. This means that each bar on the chart
represents one day of price action. This makes it possible to effectively view price
action over periods of three to six months on a single chart on a computer screen.
I use the word effectively, as it is possible to use a daily chart to view years of
 Harriman House Trading Sampler / 62

price action if you want to, but specific levels are much harder to detect on one
graph over such a long period.
It suits my strategy to consider three to six months of action on a single chart as
I have found that over this period of time historical price levels are more reliable.
This is as opposed to shorter periods where historical price levels are less reliable
and longer periods where the price levels are more obscure and they are more
difficult to spot.
For example, if price has reversed at a certain point twice over a period of six
months, one could deduce that there is a good chance of price reversing again at
this point, when it is reached. Even if it does not reverse the next time it gets to
that level, you could at least expect some strong movement. Conversely, if the
chart you are looking at represents six hours of data and price has reversed at the
same level twice over the period, the probability of a further reversal is much less.
This principle of price repeatedly respecting a previous level is illustrated in Figure
2.1 – you can see that price reverses at around 1.4567 three times in the period
from June to August 2011. Please be mindful that this chart is for illustration
purposes only and although it represents what happens a higher proportion
of the time, I could just as easily find an example where price did not respect
historic levels.

Figure 2.1 – daily chart showing price respecting historic levels

 Harriman House Trading Sampler / 63

Clean charts
I consider the use of clean charts to be key to successful technical analysis.
I am sure that if you are reading this book, you will have had some exposure
to the vast amount of indicators, oscillators and chart notation that is available
to help inform your trading decisions. Whilst many traders seem to use these
tools, it is worth remembering that over years of use, no single indicator has been
developed that consistently produces gains in the currency market.
Indicators are often marketed as foolproof signals that will tell you when to enter
and exit trades, but when considered for what they actually are, the sheer amount
of people who swear by them never ceases to amaze me.
Every single indicator in existence, from RSI to MACD to a simple moving
average, is derived from previous price action. More often than not, closing prices
are taken from a set number of periods, depending upon the time frames you are
considering, and manipulated to form a moving average whose properties change
depending upon the movement over that period. What’s more, this moving
average lags behind price action, in that its movement trails that of price. This lag
often means that the movement the moving average indicates has already taken
place, or is already taking place, by the time the indication is made.
I hear you ask – Surely this just produces a line that shows how price has moved
in the past? Correct.
But do we not already have that – a line that graphically represents the movement
of price in the past? Correct.
So is it not logical to conclude that out of the two lines I have available to me,
it would be better to rely on the actual representation of price now, rather than
a lagging representation of previous price action? Yes!
Two versions of the same chart are illustrated in Figures 2.2 and 2.3, one with a
number of the more popular indicators included (MACD, RSI, Bollinger Bands
and a simple moving average, as labelled), one clean.
Consider this. When looking at these two charts with the primary goal of
identifying levels at which price has reversed in the past, do the indicators help or
do they confuse and clutter things? My personal opinion is very firmly the latter.
 Harriman House Trading Sampler / 64

Figure 2.2 – chart with some of the more popular indicators

Figure 2.3 – the same chart, without indicators

 Harriman House Trading Sampler / 65

A small caveat should be noted to my unprovoked abuse of indicators. Whilst I

find no utility in using indicators to predict future price movements, certain ones
can make it easier to identify trends. For example, I often use a simple moving
average to help me determine my directional bias. More on this later.

2. Candlesticks
I have explained how I use daily charts of price movement to represent where
price has moved over a period of time. It is now important for me to explain how
I like to see price movements represented on the chart.
There are a number of representations of how price has moved, with my
preference being the use of candlesticks. Candlesticks, a Japanese method that was
first introduced to Western chartists by Steve Nison in the early 1990s, illustrate
the open, close, high and low of price during a particular session. Session refers
to the time period of the candlestick – it could be a minute, a day, a week or
a month of trading. So, for example, a daily candlestick will show where price
opened that day, where it closed, and what prices its high and low reached.
An example of a classic bullish candlestick can be seen in Figure 2.4. Here, you
can see the market closed higher than it opened and you can also see the high
and low of the day. The main body of the candlestick shows the opening and
closing prices, and the thin line that extends above and below the main body
– known as the wick or the tail of the candlestick – illustrates the high and low
prices of the day.

Figure 2.4 – a classic bullish candlestick

 Harriman House Trading Sampler / 66

Indicators of directional bias

The beauty of candlesticks, and the reason I use them over other methods such as
bar charts, is their simplicity. At a glance it is possible to gain a real insight into
the important levels of a period and also the movement within these levels – the
open, close, high and low points of the period in question. It is this knowledge
of movement that helps me form a bias about the possible future direction of a
currency pair.
Every trader will have their own preference as to the format of their candlesticks,
but generally for a session during which price increased (opened lower than it
closed) the body of the candlestick will be coloured green, blue or white and for
a session during which price decreased (closed lower than it opened) the body
of the candlestick will be coloured red or black. In my own charting I prefer to
use white for an up-candle and black for a down-candle.
For example, in the session illustrated by the candlestick in Figure 2.5 (which is a
classic bullish pin candlestick), we can see that price opened and closed at similar
levels. The candlestick is white, which tells us the opening price of the session was
lower than the closing price – this was an up day. We can also see that at some
point between these levels price dropped substantially (as indicated by the long
lower wick), but returned to just above its opening level before the session closed.

Figure 2.5 – a classic bullish pin candlestick

What does this candlestick tell me?

The fact that price opened and closed at a similar level suggests that there exists
an element of uncertainty in the market, which once overcome could lead to
a substantial movement in price. I also deduce that since price fell and then
returned to its former levels within a session, there must be considerable buying
pressure below the open and close levels. From this information alone, it is logical
 Harriman House Trading Sampler / 67

to conclude that the market in question could be due for a movement upwards,
built upon this buying pressure.
Of course, the bullish pin candlestick is just one of many that can be used to form
a bias as to the possible future direction of price. I have used it as an example
because it is one of my favourites; other traders will have their own favourites.
If you want to find out more on the topic of candlestick anatomy and different
types of candlesticks there is a wealth of information available online. See the
‘Useful resources’ section for some sources I would recommend.

Candlestick patterns
Whilst it is possible to trade using single candlestick formations such as the pin
bar, further advantage can be gained when groups of candlesticks form patterns.
Such patterns can be strong indicators of a directional bias and with a little bit
of practice these can become very simple to identify and act upon.
There are a huge number of patterns available and just as with individual
candlesticks traders will have their own personal favourites. I trade only a small
number of patterns that I deem to be the most reliable on the timeframes I use
and in the way that I trade them. These are described a little later on in the book.
It is important to realise that while I limit the number of patterns I use because
it suits my strategy and risk tolerance, you should not feel restricted to the same
limitations.
To illustrate the concept of trading with candlestick patterns, I will use one that
I trade regularly; the inside candle. Inside candles are formed when one session’s
price action is completely engulfed by the price action in the previous session.
This is illustrated in Figure 2.6.

Figure 2.6 – inside day candlestick

 Harriman House Trading Sampler / 68

What does this pattern tell me?

I can see that during the inside session, price was unable to reach either the high
or the low of the previous day. This, in much the same way as a pin bar, indicates
a level of uncertainty and consolidation in the market. I like to think of the inside
session as the spring that fuels the movement of price being coiled. This simple
analogy reminds me that when price does start to move it will continue to do so
and therefore once movement does take place a trade can be entered.
It is worth noting that inside candles alone are not what I trade – it is the
subsequent break of the engulfing bar after the pattern has been seen that
indicates entry. Finer details such as entry and risk parameters will be covered
in ‘My favourite setups’.

Risk management with candlesticks

It is possible to use the levels indicated by a candlestick to set risk management
parameters. I have a whole chapter on risk management so I go into this in detail
there, but for now I will say that the highs and lows indicated by a candlestick’s
wick are often the points at which any directional bias gleaned becomes invalid.
So, for example, looking at Figure 2.5, if price were to fall below the low of this
session (the lower wick extreme) in the next session then my suggestion that
there was enough buying pressure to hold price above this low would be proved
wrong. The basis on which I entered the trade would thus be incorrect and so I
would not want to be in the trade. Accordingly, if I had entered a long trade in
the session that followed this candlestick, the low of the bullish pin is the point
at which I would have placed my stop loss.

3. Historic price levels

Now I have shown how candlesticks represent price movement over a period of
time and I have illustrated the concept of using the candlesticks and the patterns
they form to get a sense of possible future price direction, we must look at
where we would expect these patterns to form and what sort of movements they
indicate. This key insight can be gleaned from studying previous price action.
Regardless of what any trader tells you and however much work they claim to
have put into developing their infallible strategy, each and every one of us parts
with our money on a very simple assumption: that what has gone before will
come again. More succinctly, where price action has occurred in the past, we have
to assume it will happen again and it will happen in a similar way.
 Harriman House Trading Sampler / 69

This assumption will not be accurate in every case – many times I have watched
price soar through a level at which it had previously reversed and vice versa – but
analysis of past price action and projection of patterns into the future is how
traders gain their competitive edge in the market.
Patterns won’t repeat in the same way every time but a key point to remember
– and one that I will cover in more detail in the psychology section of this book
– is that not every trade is going to be a winner. Obvious, I hear you say? Well,
in a sense, but consider this. If I know and accept that I will have losing trades
in advance, then why should I be disappointed when I make a losing trade? If I
have a reliable long-term strategy, then surely each losing trade I make increases
the odds that the next trade will be a winner? A certain level of detachment like
this is required to enable traders to execute strategies correctly and by achieving
this detachment it becomes much more likely that strategies will produce positive
longer-term results.
The way in which I use historic price levels is by observing support and resistance.

Support and resistance

If price reverses to the downside more than once at a similar level, that level is
referred to as resistance. Conversely, if price reverses to the upside more than
once at a similar level, that level is referred to as support.
To illustrate the power of support and resistance price levels in predicting future
movements, in Figure 2.7 I present a daily chart spanning six months of EUR/
USD price action.
 Harriman House Trading Sampler / 70

Figure 2.7 – historic prices initiating reversals in EUR/USD

As you can see in the chart, price rose to around 1.4535 in early July, then reversed
and took a substantial drop of about 600 pips. About a week after peaking, price
bottomed at just below 1.4000 and started to pick up again.
The rise was a little slower than the fall but sure enough after nearly two weeks
price approached its previous high at 1.4535. What did it do when it reached that
level? It did exactly the same as it had a few weeks earlier; it turned and reversed!
Now, I should say that in hindsight it is easy to look at a chart and pick out points
at which the market did as you would expect it to, so although price had reversed
at this level recently, for some traders this alone might not be enough to warrant
action. What I would have picked up in live trading is the apparent importance
of this level and I would make a note to observe future price action at this level.
Having marked this resistance level as one to watch, I wait. The ability to wait
is another often overlooked, but key, trait that every trader must develop. I wait
until price starts to head towards the level I have highlighted and then I watch. As
you can see in Figure 2.8 – zoomed in to the relevant section of the chart – sure
enough price reached 1.4535, in this instance slightly higher, but was not able to
close above it and in due course reversed. On this occasion it never looked back.
 Harriman House Trading Sampler / 71

Figure 2.8 – price hitting slightly higher than 1.4535 in EUR/USD

So how would I trade this?

Having identified the key historic price levels, I would wait for a tell-tale sign
that history was going to repeat. This tell-tale sign comes from price action,
illustrated through candlesticks. As you can see, towards the end of August, a
bearish pin bar formed, with the wick breaking, but the session not closing above,
the previous two highs.
This indicates to me that although during the session of the bearish pin bar the
price rose above 1.4535, it was not able to close above this level due to selling
pressure in this area. As mentioned earlier, when I see a pin bar candlestick I use
this to help me form a directional bias for my trade. In this case, the combination
of the resistance level holding once again and the bearish pin bar would have
triggered a short entry for me, with my stop loss set at the high of the pin bar
and entry at the open of the following candle.
 Harriman House Trading Sampler / 72

Trend channels
This basic concept of history repeating itself in the form of recurring price
patterns can be applied to many different strategy shapes and sizes. Some traders
prefer trend channels, for example, rather than horizontal levels of support and
resistance.
A trend channel forms when price trends upwards or downwards between
diagonal upper and lower channel lines, the upper channel line acting as resistance
and the lower channel line acting as support. An example trend channel can be
seen in Figure 2.9.

Figure 2.9 – a trend channel in EUR/USD

Personally I use trend channels much less than simple support and resistance
as I feel a trend channel can cloud judgment. Also, it can suggest a continuing
trend when, by the time the channel is recognisable, the trend is reversing. But
this is not to say trend channels have no use. No two traders are identical and
no two traders use identical methods so you might find channels work better
for your method.
 Harriman House Trading Sampler / 73

4. Timing
By timing, I mean the time at which I analyse the market and place my trades.
Most of my trades are taken at what is referred to as New York close; this is 5pm
EST. The forex market is open 24 hours a day and as such there are no natural
opening and closing times for daily candlesticks. As a result, it is necessary to line
up the candlesticks with the times that reflect the most accurate representation
of the day’s trading activity.
The forex market is unofficially split into three main sessions, each of which is
based around the banking hours of the three major financial continents: Europe,
Asia and North America. The close of the North American session is at 5pm EST
(as New York banks close for the day at this time) and the opening of the Asian
session (as Sydney banks open for the day). I find in my own trading that by
basing my analysis (and my trades) on this particular reference point in the day
I get the best results. In the diary, you will see that most of my analysis is made
on the charts as they are at the New York close.
 Read on...

Diary of a Currency Trader

A simple strategy for foreign exchange
trading and how it is used in practice
By Samuel J. Rae
Samuel takes you through his personal journey and how he got to
where he is today followed by a step-by-step, illustrated description of
the strategy he uses and the principles that underlie his approach.

Available as paperback and eBook. Free eBook with paperback purchase.

www.harriman-house.com/diaryofacurrencytrader
Crowd Money
by Eoin Treacy

Chart Reading Versus Technical Analysis

What we will cover in this chapter
• Technical analysis and chart reading are very often confused but are in fact
two separate disciplines.
• Chart reading looks on price action as a reflection of how supply and demand
are interacting, tells us which is dominant and allows us to imply the actions,
objectives, motivations of market participants.
• Technical analysis looks at the relationship of price to itself and attempts to
identify patterns to take advantage of.
• Chart reading allows us to take a dispassionate view of the market, enabling
us to tailor our approach to the reality provided by the market and script
how trends will eventually end.

Drowning in indicators
I began my career in the financial industry as an account manager at Bloomberg,
primarily covering the Netherlands, Belgium and Luxembourg from London. The
team I was initially part of was mostly comprised of people who had previously
worked in the fixed income sector either as traders or salespeople. On my first
day they sat me down in front of the Bloomberg terminal and a pile of bond
math manuals and told me to start reading and playing with the system. As you
can imagine, bond math is a fairly dry subject and when I got to reverse repo
calculation they told me I had covered enough. I spent the next couple of weeks
getting to know the system and happened upon the charting package.
This was a revelatory moment. While I initially found the figures presented on
the various calculators and spreadsheets to be fairly esoteric, the charts of price
action appeared to be a language that contained discrete information if only I
 Harriman House Trading Sampler / 78

could learn to interpret it. I took on the task of learning about every available
indicator in an effort to broaden my knowledge and to satisfy my intellectual
curiosity. I quickly became known as someone who could talk to clients and
answer their questions about technical analysis.
I subsequently went on to teach seminars all over Europe on the use of technical
indicators and have to admit to feeling quite satisfied with myself, at least
initially. However, after a while clients began to ask what seemed like an awkward
question: “Why?” Why does technical analysis work?
This presented me with a problem because while I knew how to employ various
indicators I could not explain why the vast majority of them worked. I began
to whittle down the number of indicators I was willing to talk about to those
I could explain in a rational, coherent way. The result was that having had an
arsenal of almost a hundred indicators, I was left with a bare handful I felt could
be explained in clear simple terms without relying on some abstract theory.
I was becoming disillusioned with the whole subject and began to think that I
was wasting my time. A turning point in my analysis came when I met David
Fuller in 2003. His focus on chart-reading rather than indicators was a light-bulb
moment for me. His description of indicators as psychological crutches upon
which we come to rely resonated with my experience of the field. His core belief
that everything we need to know about supply and demand is right there on the
chart if we are willing to allow ourselves to see it reawakened the passion I felt
when I saw my first chart.
I had tried just about every technical indicator from momentum trackers to
oscillators, from Elliott Wave to Fibonacci to DeMark and found them all
wanting. They seemed to work some of the time and not others and I could
not explain why. Some were better in a trending environment while others were
better used in a range. Some were more reliable than others because of popularity.
But none gave me a sense that I could rely on them. I even tried using them in
conjunction so that if three indicators gave me a signal I would place greater
significance on that. Still my results did not satisfy. Today, of all the technical
indicators out there, the only one I use with any kind of regularity is the 200-day
moving average (MA) because it represents the trend mean. The closest thing we
have to a natural law of physics in the market is that when prices become wildly
overextended relative to the trend mean, they will revert back towards the mean
in due course. The 200-day MA is also one of the most widely used indicators
and therefore often represents a self-fulfilling prophecy. For example, investors
will be looking for support or resistance to be encountered in the region of the
MA so they will adjust their actions to allow for such an eventuality. This simply
increases the likelihood of its happening. In the fixed income futures and currency
markets widely regarded Fibonacci levels have a somewhat similar influence.
 Harriman House Trading Sampler / 79

Rhythms of the market

As we approach the subject of chart reading it is important to accept that the
interpretation of price action while useful is not a panacea. We can observe
that the rhythm of a chart will persist until it breaks down and can tailor our
investment strategy accordingly but it will not tell us at what level a market will
eventually top or bottom. Nothing else can give us that information either. In an
effort to increase certainty many people’s first instinct when they consider price
action is to think of it as a complicated subject. The first thing they want to do
is draw trend lines or break up the data into what they consider manageable
chunks. Still others deliberately complicate the subject in order to create the
illusion that they have some privileged piece of knowledge they will share with
you for a price. Others will complicate the subject in order to help justify their
positions at financial firms. The reality David Fuller has expounded for nearly 50
years is that price action is simply the interaction of supply and demand. Nothing
more than the price action is required in order to comprehend how the forces
of supply and demand are aligned. Once we understand this we are in a better
position to frame our interaction with the market.
While Benjamin Graham (1894–1976) could never be considered a chart reader,
his thoughts on the complication of analysis (taken from The Intelligent Investor)
are equally relevant here:
“Mathematics is ordinarily considered as producing precise and dependable
results; but in the stock market the more elaborate and abstruse the
mathematics the more uncertain and speculative are the conclusions we
draw there from. In forty-four years of Wall Street experience and study
I have never seen dependable calculations made about common stock
values or related investment policies that went beyond simple arithmetic
or the most elementary algebra. Whenever calculus is brought in, or higher
algebra, you could take it as a warning that the operator was trying to
substitute theory for experience, and usually also to give to speculation
the deceptive guise of investment.”
When supply and demand are in balance markets range. When there is a
difference between supply and demand prices trend until they come back into
balance. We can observe this drama unfold via price charts. The dominance of
demand over supply that creates an uptrend can just as easily be considered in
terms of crowd psychology as an idea captures the imagination of ever more
people and influences their actions. Every market is a crowd and while every
crowd is different they all have common characteristics. By acquainting ourselves
with the idiosyncrasies of the crowd we can measure our actions to the rhythm
of that market.
 Harriman House Trading Sampler / 80

The aesthetic case

Most people are familiar with David Attenborough’s documentaries or scenes
from Mutual of Omaha’s Wild Kingdom, and can envisage a herd of thousands
of wildebeest flowing across the Serengeti in a mass migration. Such a sight offers
a true sense of nature’s wonder but it is also one of the best examples of crowd
psychology at work.
Some might find it odd to have the financial markets described in aesthetic terms
because they are more familiar with the venality of a certain class of banker or
are disgruntled with having to foot the bill for various bailouts. However, there
is unquestionable beauty in the way an idea captures the imagination of the
investment crowd. If an investor can identify the market with the most aesthetic
attributes, such as a clear trend of demand dominance coupled with improving
governance and abundant liquidity, they are considerably more likely to profit
from their participation than might otherwise be the case.
There is no denying that just as with the wildebeest, being a part of the investment
horde can at times be a stressful experience. Individuals can get hot under the
collar. It’s hard to think straight when everyone around us is rushing towards
some half-imagined goal. The precipice is difficult to visualise when all that one
is presented with are other people heading in the same direction. We need to
participate with the crowd if we are going to profit from it, but wouldn’t it be
better to adopt the position of the naturalist who is ready to get into the thick of
the crowd dynamic but who can hold his own emotional participation in check?
Once we develop a sense of what to look for in a chart pattern, the simple
truth that a beautifully trending market is easier to make money from than a
violent choppy range becomes self-evident. Once we can identify the beauty and
consistency of a well-defined uptrend then we are presented with an excellent
opportunity to make money from a trend-running strategy over the medium to
longer term.
For instance, compare the performance of Singapore’s stock market index between
2003 and 2008 with its performance between 2008 and 2012. Ask yourself which
market you find more attractive to look at. Then ask yourself which would have
been easier to make money from.
 Harriman House Trading Sampler / 81

Singapore Straits Times Index 2001–2007

Singapore Straits Times Index 2007–2013

The period between 2003 and 2008 was remarkable for the consistency of the
advance until the big pullback in late 2007. All one would have had to do was
be invested to have made money. The subsequent period is completely different.
 Harriman House Trading Sampler / 82

There have been wild swings, huge volatility and lengthy ranging. The most
nimble traders made money but investors have had a more difficult time. If
we pursue a trend-running strategy we seek out the instruments with the most
beautiful trends, hold them as long as they remain beautiful and move onto the
next opportunity when their beauty fades.
It might not seem sporting but when investing, we all like to shoot fish in a
barrel. We set out with the full intention of betting on the favourite because that
is what has the greatest potential for making money. (This is where investing and
gambling differ sharply.) Chart reading is not an intellectually difficult subject but
it is emotionally subtle. It is easy to speak of such events but it is more difficult
to put into practice because of the relationship we develop with our investments
and the reliance we form on a market that has performed well for us. This is why
we need to develop a disciplined approach to interpreting price action that relies
on facts rather than esoteric theories.

Disciplined and responsive interpretation

Price action tells us everything we need to know about the interaction of supply
and demand. However, the interpretation of that information requires that we
allow ourselves to become responsive to the cues offered by a chart. Long-term
price charts demonstrate the movement of investment crowds in and out of
markets. The evidence of accumulation and distribution of positions is evident
in price history if we have the humility to recognise it without super-imposing
our own assumptions. From the perspective of an investor, what we would
call a beautiful chart will show a clear pattern of demand dominance that is
recognisable from a quick first impression.
 Harriman House Trading Sampler / 83

Japanese yen / US dollar 2008–2013

This chart represents the Japanese yen / US dollar cross rate. The yen trended
higher against the dollar from 2007 until 2011. This trend was characterised by a
series of ranges one above another. When the rate became overextended relative
to the trend mean, a range ensued which allowed it to catch up. On pullbacks it
found support in the region of the MA before rallying once more. This rhythmic
pattern of demand dominance over a number of years changed in 2012.
The yen’s strength over a number of years was progressively eroding the
competitiveness of Japan’s export sector, which was crying out for assistance.
In early 2012 the yen posted its biggest decline in years. This move was clearly
different to what had occurred previously because it was the first occasion that the
rate failed to find support in the region of the trend mean. It subsequently failed
to push back above it on a sustained basis. These two factors clearly signalled
that the previous rhythm of the market had changed. The break below 0.012 in
late 2012 confirmed the beginning of a new downtrend.
The evidence of change in the relationship between supply and demand is there
on this chart if we allow ourselves to see it. However, when we have positions in
a market which has rewarded us the temptation to see what we want or expect
is intense. Therefore we need to develop a disciplined approach so that we can
identify technical facts about how supply and demand are interacting before
attempting to draw conclusions. Once we have facts, we can be responsive by
assessing the maturity of the market via filter questions, and then decide whether
the trend remains in motion or if there is evidence of trend-ending characteristics.
 Harriman House Trading Sampler / 84

There wouldn’t be a market without people so we should at minimum apprise

ourselves of the characteristics common to every crowd regardless of class, race,
colour or creed. Learning to spot extremes of emotion, the loss of a critical
perspective, idolisation of the investment and other cues are invaluable in
identifying major top and bottom characteristics. Equally important is how we
are affected by the psychology of the crowd once we participate with it. Knowing
ourselves and how we react to predictable stimuli is essential if we are to navigate
our way to a wealthier future.

The final arbiter

Chart-reading is an invaluable tool as part of a holistic approach to investing.
As we develop sensitivity to themes capable of motivating investor interest
and which have a solid fundamental basis, where we assess whether liquidity is
expanding or contracting and whether the trajectory of governance is progressing
or regressing, price action is the final arbiter. Dispassionate analysis will help
us to identify investment opportunities, entry and exit points, major tops and
bottoms. However the mental stability necessary to hold a position, maintain
money control discipline and the strength of character to exit at an appropriate
time are equally important attributes which need to be fostered if we are to be
well-rounded, wealthy investors.
 Read on...

Crowd Money
A Practical Guide to Macro
Behavioural Technical Analysis
By Eoin Treacy
Analysts David Fuller and Eoin Treacy count some of the world’s
largest sovereign wealth funds, pension funds, traders and investors as
subscribers. Their approach to measuring the rhythm of the market
has been the secret weapon of alpha generators for decades. Now
for the first time a book is available that sets out the approach to
market analysis they employ on a daily basis at FT-Money.com.

Available as paperback and eBook. Free eBook with paperback purchase.

www.harriman-house.com/crowdmoney
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