Discover Tom Hougaard's favourite Forex trading strategy. Practical trading examples, detailed charts and visual aids help you learn and apply this strategy to your own currency trading.

Transcript:

Introduction:
This is the final chapter and this is what we’ve been building up towards. In this chapter I will be introducing to you my favourite trading strategy that I employ in the market every single day.

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It is time to introduce the trading strategy, which I have been talking about throughout these chapters, but before I give you the particulars, I like to tell you in my own words what the ethos behind the strategy is, so you have an idea of how to trade it.

I run a live a trading room where people from all over the world log into my site and watch me trade. Talk about the pressure being on you beyond the pressure of simply trading your own account. The Reverse Divergence Strategy is one which I use repeatedly in the live room. I know that when I spot one of these setups, there is a better than 70% chance that I will have a winning trade.

But did you hear what I just said? I said better than 70%. But it doesn’t mean that I will be guaranteed a winning trade. Anything can happen. So when I place a trade, I know full well that I may simply be wrong. I have to accept it. It doesn’t mean that I have to like it. Who on earth likes to lose money? But that is the nature of the game.

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The coin game has taught me that there is a whole lot of randomness around, and my only job is to carry on trading, and carrying on playing the game.

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When it comes to Forex trading, and indeed other kinds of trading, I have a mantra, which I tend to stick to consistently. It goes like this:

I want to fade the short-term trend in the direction of the long-term trend.

But of course that requires a bit of explaining. So let’s go through this mantra again:

What does “fading” mean?

Fading a move means that you go against the flow. It means that you believe the current move is a temporary move against the major trend and that the real trend is in the other direction. It means that if the market is going up temporarily but you believe the overall trend is down, you are on the lookout for selling short the market. You are “fading” the current up move, because you believe the market will shortly or immediately reassert the trend lower.

The second question that needs to be answered is the definition of the short-term trend and the long-term trend.

My long-term trend may be someone else’s short term trend. If I am day trading the Forex market, I will define the trend on the 1-hour and 4-hour chart. But I will place my trades using a 15-min or even a 5-min chart. I am often in my trades for 20 minutes or more. And I tend not to risk more than 30/40 pips on any position


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Consider this for a moment. Most human beings are perfectly rational, and are fully capable of holding down jobs, professional careers, being parents, balancing their cheque books, and behaving in socially acceptable manners set by the standards of society. When they enter the trading arena, they expect the same kind of order, but it isn't there.

In this world of mine, order is wishful thinking. There is no rime or reason to it. There is no order, there is no structure. All there is is what you have trained your eyes and mind to see in the market. I literally had to train my eyes to see the order that newcomers don’t so readily see. It takes time and practice.

In order to help my eyes I put up some visual aids on the chart. We have already discussed these aids at length, but we will look at them again.

When I am looking for a Reverse Divergence setup, I want to use the following visual aids.

I use an 89-period moving average to define the trend of the time frame I am trading. It is only a visual aid and although it is vitally important to my trading, its only function is to tell me if the trend is up or down.

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When I am looking for trading setups, I will start off by looking at the 4-hour chart. Currency markets have a remarkable propensity to trend, and I prefer not to trade against the trend set on the 4-hour chart.

So if I am looking at a 15-min chart, the 89 MA may say the trend is down, while if I looked at the 4-hour chart with the same 89MA, it may say the trend is up.

How do you solve this conflict between two timeframes?

You don’t! You can’t solve it. There is nothing to solve. You have to accept and embrace the fact that trading will never be perfect. If you are waiting for the perfect set-up, you will wait for a long time. It rarely happens. When you think it is too good to be true, it probably is. I have to deal with what is, right here, right now. But don’t forget that while the trend on the 4-hour chart is down, there may still be some very good trading setups on the 15-min chart that calls for you to trade against the trend of the 4-hour chart. That is perfectly ok, as long as you know where to get out, if you are wrong.

The other visual aid I use is the Oscillator. I use the standard settings which come as standard on all charting packages. The settings are 14 – 3 -3.

And that is it.

I know so many traders who have all sorts of rubbish on their charts, it makes the screen look like a circus arena. Trust me when I say that the more junk you have on your screen, the more confused you will become. You might want to consider taking off all of your indicators, and begin to simply appreciate the beauty of the pure chart. I found that over relying on too many indicators gave way to “paralysis through over analysis”.

I could not make up my mind until all the indicators were all lined up. By the time they were all lined up, it was too late.

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It is time to get into the nitty gritty of the Reverse Divergence strategy.

My reverse divergence setup essentially involved buying into a market which is already trending higher, or selling short a market which is already trending lower. And I use the 89 period MA to define the trend.

What I am looking for is as follows:

My trend indicator needs to point in one direction, up or down. If the trend indicator is indicating higher, I will be looking to buy the market. The market should be trading above the 89 period moving average as well. If the trend indicator is pointing down, I will be looking to sell the market and I want to ensure the market is trading below the 89 period moving average.

Lets take a practical example. On this chart the market is trading below the 89-period MA and the 89 MA is pointing down. You can also see that the market has made a high and now looks set to potentially make a lower high. This is indicated by the blue line on the price chart.


On the momentum indicator where I use the stochastic for this setup, you can see how it is making a series of rising highs. I have drawn a blue line on the momentum indicator, signifying that it is making a rising high.

The peak on the price chart corresponds with a peak on the momentum chart. The secondary peak on the price chart, which is lower than the first peak on the price chart, signifies a downtrend, but on the momentum indicator the corresponding peak is higher than the previous peak. And this is what is known as a reverse divergence.

The red line you see in the middle of the chart image is my attempt to draw a line where the market will find resistance. There is not specific law to drawing this line, and it is largely the result of trial and error, and years of experience.

On this trade I sold the EURO Dollar short at 1.4217. I immediately placed my stop loss at 1.4245, which was the high made on the news announcement which caused the spike higher and lower. My feeling at the time was that if the market could take out this level of 1.4245, it would stand a good chance of running even higher, and I would not want to be in that trade anymore.

The market backed off, and eventually traded below 1.4200. At this point I moved my stop loss from 1.4245 down to my entry point at 1.4217, so I knew I could not lose a penny on the trade.

It was getting late in the day at this point, and I moved my stop loss down to 1.4210, hoping I would not get stopped out during the night. Unfortunately for me I did get stopped out, because when I woke up early next morning, the market was trading a 1.4260.

Still, I got stopped out of my trading with a small profit and with the ability to trade another day.

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Lets take another example, this time on the Sterling Dollar pair. With the benefit of hindsight I love this trade because I did everything right. Sterling dollar was trading through and above the 89 period MA on the 30 min chart, and I was looking for a place to buy the market.

The old rule of support and resistance gave me a helping hand in this trade. The horizontal black line identified areas on the chart where there had been distinct support and resistance in the past.

The currency was trading above the 89-period MA, so I knew the market was bullish. Now it was a question of keeping an eye on the oscillator to get an entry signal. On the chart on the screen you can see how price is making a rising low, while the Oscillator is making a new low.

What I am particularly pleased about on this trade was that although the Oscillator made a new low and price made a higher low, I did not immediately buy the market. I patiently waited for the market to hit an important area of support before I committed my working capital to the trade. As a matter of fact I waited two hours, waiting for the right price to come to me.

Was I tempted to jump the gun and get in on the action? Of course I was. I am not a robot. I am a human being, and I have to keep check on myself and the 4 trading fears constantly. Trading fear no 3 states: I am afraid to miss the move. Well, in this case I may have been afraid to miss the move, but I waited patiently, and was filled on the trade at 1.6809. I always take a screen shot of the market at the time of my trade for future reference. It is a brilliant way to learn and to spot flaws in your analysis, when you review your trades after the market is closed.

My stop was in this case 40 pips, which meant that if the market traded down to 1.6769, I would have been stopped out.

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When you trade the reverse divergence on a 5-min chart vs. trading the same set-up on an hourly chart, your expectations are different. You are not expecting to clock up hundreds of pips from trading the reverse divergence on a 5-min chart. However, you would expect that if you are trading the setup from the perspective of a 60-min or 4-hour chart.

Furthermore when you are trading it on a 5-min chart, you may want to increase your stake size but reduce the stop-loss. If you are trading it on a 4-hour chart you may want to use a larger stop-loss, but using smaller stake size.

My preferred time frame to trade the reverse divergence is on the 15-min and 30 min chart. I rarely use stops of more than 40 pips. If I am trading some of the Yen crosses such as the Sterling Yen, I may use a larger stop, but I will reduce my stake size to bring my money management into line with the parameters set for my trading account. I don’t want to risk much more than 1% or so, on any trade.

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This concludes my trading strategy. My hope is that you will run with this strategy and make it your own. The reverse divergence strategy is perfect for building trading discipline in relation to the 30-trade experiment. If you commit to follow this strategy through thick and thin for the next 30 trades, you will build trading discipline. You will do what very few people have done, which is to commit to learn to trade properly.

It is important to have a good strategy and you have that now. What is more important is that you have trading discipline, and that you can follow a trading plan. My aim with this course was from the beginning to equip you with both the technical and the psychological knowledge to succeed in one of the toughest jobs in the world, but also one of the most enjoyable games in the world. I hope you enjoyed it. My name is Tom Hougaard, and I wish you all the trading success in the world.