Avoiding false signals

Immediately following a crucial night in UK following Scotland’s NO verdict in the independence referendum last week, there were fewer opportunities in the market due to few significant data releases. Thus, USD is holding up, while EUR and GBP remain flat (although GBP does seem healthier than EUR).

Looking at this market situation then, I want to concentrate on a mistake that newbies often make: trading against the market trend.

When a prolonged market trend is on the way, newbies (who are often out of the market or have closed their position too early) tend to bet on market reversal. This strategy can prove very unprofitable, as markets tend to provide several false signals before inverting. Remember: a healthy trend is much more likely to continue than to reverse.

So the question is: how can you follow the trend and avoid these false signals?

The key is to follow the flow of big players such as Banks and Hedge Funds. If volumes accompany prices, trading against the trend will be disastrous. A good strategy is to exploit this significant information in order to choose your best trading approach. Take a look at the USDJPY chart below:

1 USDJPY has been rising since the middle of August, gaining 6.5% in just one month. The OBV (indicated by the blue line on the chart) follows the price chart without showing any divergence. Thus, we should follow the trend here, as betting on a reverse at this time would be unprofitable. And traders who didn’t enter at the beginning of the trend should exploit correction here in order to enter in the right side of the market. Look at the 30-minute USDJPY chart below:

2In the last 5 days, traders could go long in the first trading hours of the 17th September, at 107.16, watching out for the exit signal that was provided yesterday at 108.50. This is a very strong signal. The key here is to avoid ‘sell’ signals in this market environment.

To conclude, order book analysis allows traders to capture the right side of the market. The strategy outlined above is a good starting point, but it can be improved by applying other tools such as entry and exit strategies or reversal strategies- this will be covered in due course.

Questions? Tweet me @LFXGabriele.

— For more on the trading techniques used by Gabriele and the LFX traders, try our new Forex Trading Course. To find out more or purchase the course, click here