Appendix

Trading Strategies

In This Appendix

Finding out what type of trader you are

Getting actionable trade ideas

Developing a strategy based on your trader type

The forex market is the largest financial market in the world. A market with more than $5 trillion a day in turnover presents plenty of opportunities for the retail trader, but those opportunities won’t be handed to you on a silver platter — you have to work hard to ensure you’re successful in the forex market. In this appendix, we set you up to do exactly that by helping you choose the right trading strategy for you and giving you tips on implementing that strategy.

What’s Your Sign? Determining Your Trader Type

There are thousands of forex strategies, but you need to choose the one that works best for you. At FOREX.com, we’ve grouped traders based on personality types and developed specific strategies for each. We’ve identified three trader types:

• The scalper: A scalper is a trader who looks for short, minimally profitable opportunities in the market that can add up over time. If you’re a scalper, you don’t have the patience to hold a position for a lengthy period and you grow bored easily when keeping trades active for too long. You’re motivated by the excitement of seeing fast-moving markets, sometimes trading around major news events to realize the vast potential of a large move in a very short period of time. You aren’t happy about placing a losing trade, but you’re typically less impacted both financially and emotionally due to the small nature and frequency of trades that you place.
• The swing trader: A swing trader is someone who typically enjoys staying in a trade for as little as a few hours to potentially days. If you’re a swing trader, you like the analysis aspect of trading — finding patterns that develop and exploiting them like a cunning strategist. Because you place fewer trades on a daily and weekly basis, losing trades could have more of an impact on your psyche, so keeping your longer-term goals in mind and sticking to the plan are imperative.
• The position trader: A position trader has a much longer time frame in mind than most other traders. If you’re a position trader, you could be in a trade for months or even years if your conviction is strong enough. Usually based on a fundamental perspective of political, sentimental, or supply/demand reasoning, you brush off the fear of short-term movements. You’re much more tolerant of drawdowns and could take losses for a very long time before finally admitting defeat.

To more precisely determine what type of trader you are, take the quiz at www.dummies.com/extras/currencytrading. Note: You can move between trader types. At the start, you may feel more comfortable as a scalper, but as you become more confident, you may prefer to be a swing trader and hold trades for a slightly longer period of time.

There’s no “right” or “wrong” trader type — you just need to identify the type of trader you are and trade accordingly.

Looking at Trading Strategies Based on Trader Type

In this section, we offer some actionable trade ideas for each trader type. These strategies have been developed by FOREX.com’s research team. We’re grateful for input from Matt Weller, Neal Gilbert, Fawad Razaqzada, Chris Tedder, and our former colleague Chris Tevere.

Strategies for the scalper

In this section, we provide two strategies for the scalper. We call them the Red Zone strategy and the Opening Range Breakout strategy.

The Red Zone strategy

News trading (buying and selling around high-impact economic data) is notoriously difficult, to the point that many traders intentionally close all their trades ahead of major news reports like nonfarm payrolls (NFP) or central bank meetings. To be successful with this style of trading, you need to have a predetermined, disciplined structure — you don’t want to haphazardly place emotional trades.

One potentially effective strategy is to take advantage of markets’ tendency to gravitate toward round numbers, like 1.3200 in a currency pair like EUR/USD. These levels are significant for two primary reasons:

• Newer traders often set stop losses at or around these levels.
• Option strike prices are overwhelmingly set at round handles.

With a large swath of traders focusing on these areas, it’s no wonder that they exert a strong influence on the market. The difficulty is determining how to design a trading strategy to take advantage of this tendency.

To describe the Red Zone strategy, we like to evoke the analogy of a football game. The final 20 yards before the end zone, where good teams have historically scored a touchdown 50 percent to 70 percent of the time, is referred to as the “red zone.” (For our non-American friends, this area is analogous to the penalty area in your version of football [which Americans call soccer], where a team is more likely to score a goal on any open shot.)

Note that in both of these examples (football and soccer, er, football), a score is not guaranteed — it’s just more likely.

The same idea can be applied to trading. When an instrument comes within 20 points of a round number (the “red zone”), a continuation to that round number becomes more likely, particularly following a supportive news event.

How it works

Here are the Red Zone strategy buy rules:

• Wait for a news-driven move.
• Set a buy-stop order at 0.xx80 ($xx8.00 for gold, $xx.80 for oil).
• Set a target at 0.xx98 ($xx9.80 for gold, $xx.98 for oil).
• Set a stop loss at 0.xx60 ($xx6.00 for gold, $xx.60 for oil).

Here are the Red Zone strategy sell rules:

• Wait for a news-driven move.
• Set a sell-stop order at 0.xx20 ($xx2.00 for gold, $xx.20 for oil).
• Set a target at 0.xx02 ($xx0.20 for gold, $xx.02 for oil).
• Set a stop loss at 0.xx40 ($xx4.00 for gold, $xx.40 for oil).

Because this is a short-term trading strategy, you want to trade heavily traded markets, such as major currency pairs, gold, oil, and widely followed indices, with low spreads. You may also want to focus on trading only during times of high liquidity (when many different traders are buying and selling) to improve the speed of entries and exits.

The Red Zone strategy in action

Example 1: EUR/USD Buy

This first example (see Figure A-1) shows the ideal execution of the strategy. Following the release of weak U.S. housing data, the EUR/USD rallied strongly toward 1.2700. In anticipation of a continuation to that level, the strategy suggested placing a buy-stop order at 1.2680 with a stop loss at 1.2660 and a target at 1.2698. When the buy order was triggered, the EUR/USD went on to hit the target within 15 minutes for a winning trade. Although the EUR/USD eventually rallied another 20 pips, the highest-probability trade was the initial run to 1.2700.

Example 2: EUR/USD Buy

A few weeks later, the EUR/USD was making another run for the 1.2700 handle after the announcement of a new European Stability Mechanism (ESM) for supporting the European banking sector. As in the preceding example, a buy-stop order was set at 1.2680 with a stop loss at 1.2660 and a target at 1.2698. In this case, though, rates lost momentum before reaching 1.2700 and hit the stop about an hour after entry for a 20-pip loss. As Figure A-2 shows, the failure to continue up to 1.2700 foreshadowed further consolidation, and prices eventually rolled over. When the currency pair reverses 20 pips from the entry, the probability of a move up to the round number decreases.

Example 3: AUD/USD Sell

Our final example (see Figure A-3) is a sell scalp on the AUD/USD. After dovish Reserve Bank of Australia (RBA) minutes, rates were approaching the 0.9300 level from the topside, and the strategy suggested setting a sell-stop order at 0.9320 with a stop loss at 0.9340 and a target at 0.9302. Following entry, the pair sold off to hit the target for an 18-pip gain within an hour. Although the AUD/USD did continue to drop from there, the Red Zone strategy is only concerned with taking a small, higher-probability slice out of news-driven moves.

The Opening Range Breakout strategy

Let’s face it: The whole purpose of doing any form of analysis — whether it’s technical, fundamental, or statistical — is to try to identify higher-probability trading opportunities. One such strategy is to use a European opening range. This strategy will typically focus on EUR/USD, but it could be applied to any of the European majors.

The forex market is open 24 hours a day (Sunday evening through Friday evening Eastern time), but market activity in a given pair is not necessarily consistent throughout. The forex market is typically divided into three major sessions:

• London: Open 3 a.m. Eastern time, close 12 p.m. (noon) Eastern time
• New York: Open 8 a.m. local time, close 5 p.m. local time
• Tokyo: Open 6 p.m. Eastern time, close 3 a.m. Eastern time during the winter months; open 5 p.m. Eastern time, close 2 a.m. Eastern time during the summer months

How it works

Here are the basics:

• Identify the high and low during the half-hour just prior to the London open (2:30 a.m. to 3 a.m. Eastern time), and then look for a breakout of this range +/–10 pips or 1/10 of the daily Average True Range (ATR) and maintain above/below this level for 10 to 15 minutes. You’re trying to detect a direction of the “flow” for the remainder of the day.
• From there, look to manage this bullish or bearish bias by focusing on one-, two-, or five-minute charts and using a combination of moving averages (13-SMA, 144-EMA, and 169-EMA) and oscillators (RSI, stochastics, and CCI).
• Other factors to include are major news announcements (usually in efforts of avoidance) and the time of day (when major markets open/close, option expirations, fixings, and so on).

Noteworthy times to be aware of include the following:

• Major option expirations:
  • New York expiry: 10 a.m. local time
  • Japan expiry: 3 p.m. local time
• Currency fixings:
  • London fix: 4 p.m. local time
  • Tokyo fix: 8:55 a.m. local time
• Currency futures: International Monetary Market (IMM) closes 3 p.m. Eastern time
• U.S. equity markets: Open 9:30 a.m. Eastern time, close 4 p.m. Eastern time

Ideally, if price is struggling near these events (typically spotted by a bullish/bearish divergence with an oscillator), it could be prudent to reduce the position size ahead of time. Additionally, this type of approach may help to minimize the emotional aspect to trading, because there’s an identifiable area to know where you’re wrong (the opposite side of the breakout’s high/low).

The Opening Range Breakout strategy in action

In this example, EUR/USD made an important low during the 2:30 a.m. to 3 a.m. Eastern time time frame (which was preceded by an RSI bullish divergence with price) and shot higher shortly thereafter (as shown in Figure A-4). EUR/USD appeared comfortable above the two-minute 144/169-EMAs, while the 13-period simple moving average (SMA) remained above the EMAs, and RSI continued to find support into the key 40/45 zone. Consequently, there was no reason to divert from the intraday bullish bias.

Plus, as highlighted earlier, another factor to keep in mind is the time of day. In the forex market, most London traders tend to close their positioning between 11 a.m. and noon Eastern time, while traders in New York close between 4 p.m. and 5 p.m. Eastern time. Accordingly, price often sees a final end-of-day push, followed by profit taking (typically spotted by a bullish/bearish divergence with an oscillator) near these times of the day.

Sure enough, just after 11 a.m. Eastern time in our example, EUR/USD pushed higher once again to finally reach the intraday ATR target of 1.2927, which was then followed by a bearish divergence with RSI just ahead of noon Eastern time.

Here are some general observations regarding potential opening range scenarios per week (these are just overall findings — they should not be expected):

• Two days of the week: Won’t do much (finish roughly flat)
• Once a week: False break and potential reversal
• One day a week: Respectable movement (50 to 70 pips from highs/lows)
• One day a week: Reaches ATR target (pip amount generally equal to Average True Range using a 14-day period)

Note: If the ATR is achieved earlier in the week, the likelihood of it occurring twice in the same week is dramatically reduced. If it does occur, it’s typically in opposing directions.

As a forex trader, when volatility begins to pick up, it’s usually a time that you want to be trading currencies, not sitting on the sidelines. As a result, if this strategy has yet to achieve the ATR target on Monday, Tuesday, or Wednesday of a particular week, it may be sensible to pay close attention to this tactic on Thursday and Friday. Conversely, if the ATR is reached earlier in the week, it may be prudent to be on the lookout for potential market failures in the latter half of the week because they could be the marking of a false break and/or possible outright reversal.

Most important, the goal is not for you to think, “Wow, I need implement this strategy right away,” but rather to analyze the way that you approach the market on a day-to-day or week-to-week basis and think about whether you’re adequately taking into account time — because time may actually be more significant to a trader than price!

Strategies for the swing trader

In this section, we provide two strategies for the swing trader. We call them the Favorite Fib strategy and the Moving Average Crossover strategy.

The Favorite Fib strategy

The Favorite Fib is a Fibonacci-based strategy that takes advantage of momentum. It can be used on various time frames and markets, including forex majors, stock indices, and commodities, providing the trader with endless opportunities. The strategy could be used, for example, after some major economic news — ideally, at the earlier stages of the move following the news. But if the news merely causes a corrective rally or sell-off inside an established trend, then this strategy won’t work as well. It’s best suited for markets that are in a clear strong trend — for example, when the price is making fresh all-time, multiyear, or multi-month highs or lows.

The higher the time frame, the more effective the Favorite Fib strategy works. It’s typically used on one- or four-hour time frames, although sometimes it can be applied to the daily time frame, too. The shortest time frame on which you can use this strategy is about 15 minutes.

If the trade is based on a higher time frame, it’s a good idea to zoom in to a five-minute chart in order to refine entry.

How it works

The Favorite Fib strategy is based on some Fibonacci retracement and extension levels: the 38.2 percent and 50 percent retracement levels (the latter is not technically a Fibonacci level; see the nearby sidebar for more information), and the 127.2 percent, 161.8 percent, and 261.8 percent Fibonacci extension levels.

To understand how the strategy works, let’s say that following a strong upward move (for example, from point A to point B), the market retraces a little (to point C) because of profit taking and/or top picking, before continuing in the original direction (beyond point B). The strategy requires three price swings — the move from point A to point B, from point B to point C (correction), and from point C to point D (extension). Figure A-5 shows what a Favorite Fib buy strategy would typically look like.

In the Favorite Fib strategy, you’re interested in some part of the CD leg of the move — the bit beyond point B, where entry is based. The profit target would be determined by a Fibonacci extension level of the BC move (more on this later).

One condition for this strategy to work well is that you need momentum. By definition, this implies that point C should represent a shallow retracement of AB, and then a continuation in the original direction, beyond point B. So, if price retraces more than 50 percent, or too much time elapses before it breaks point B, then the entry signal would not be valid.

In other words, for optimal entry signal, you need a strong move from point A to point B; a relatively quick and shallow retracement of less than 50 percent to point C; and then a continuation toward point D.

When point C is established, all the strategy’s parameters can be determined.

Entry

The entry would be based on break of point B, and the objective is to ride the move toward point D, which would be a Fibonacci level, determined by the BC swing.

For a buy (sell) trade, the entry could be via a buy-stop (sell-stop) order a few pips/points above (below) point B, or it could be via a market/limit buy order after point B is broken.

Entry via a stop order ensures the trade would be triggered. However, in the case of a false breakout, it could mean buying (selling) right at the high (low). What’s more, if the market gaps, the entry may not be at the same level as the one the trader had chosen.

Entry via a market or limit order allows the trader some time to determine whether the breakout above (below) point B is genuine or false. If price holds above (below) point B for, say, a few minutes, then the trader may want to buy (sell) at the best available price. However, the risk is that the market moves quickly toward the target without a pullback, and the trader misses the opportunity.

If the entry is based on a higher time frame — like the four-hour chart — the trader may want to hold fire and zoom into a five- or ten-minute chart and wait until price closes above (below) point B on the lower time frame before buying (selling).

Targets

The Favorite Fib strategy has two targets:

• The 127.2 percent level of BC, at which point the stop loss would be adjusted to break even to eliminate risk
• The 161.8 percent extension level of BC (or sometimes the 261.8 percent), at which point the position should be closed

One way to estimate which level price would most likely extend to is by looking at the retracement of the AB swing (that is, point C). If the retracement is around 38.2 percent or lower, point D could be at the 161.8 percent or sometimes 261.8 percent extension of BC. However, if price achieves a deeper retracement — say, to the 61.8 percent or 78.6 percent Fibonacci level of AB, then you should expect point D to complete around the 127.2 percent extension of BC. Of course, this would not be a valid Favorite Fib entry, because the retracement is greater than 50 percent.

Stop loss

For a buy (sell) trade, the stop loss would be some distance below (above) point B, ideally below (above) a small fractal within the larger swing. The maximum distance between the stop loss and entry should be less than the distance between entry and the profit target. In other words, the risk-to-reward ratio should be better than 1:1 (ideally, 1:2 or better).

Final notes

• For a higher probability trade, the entry should be in the direction of the underlying long- or medium-term trend.
• The speculator should be aware of other, longer-term, technical levels when trading the Favorite Fib strategy. For example, if the 200-day moving average is at 1.8560 and the target for the long position is at 1.8580, this trade should not have been taken. In this situation, it may be better to take profit at around the 200-day average rather than hope for price to reach the 161.8 percent extension (the original profit target that was based on a smaller time frame).

  The minute you notice yourself hoping for something to happen is when you know the trade is in trouble — get out as soon as possible.

• The trader should avoid taking on opposing simultaneous trades in similar markets (for example, going long on DAX and short on FTSE, or long on NZD/USD and short on AUD/USD, and so on). If the trader is feeling bearish about the AUD and at the same time bullish about NZD, she should look for a short trade on the AUD/NZD pair instead.
• If price breaks point B, triggers the entry order, and then loses momentum prior to reaching the first target (127.2 percent), the trader should close the trade at the best available price (even if it’s worse than the entry price — why wait until being stopped out?). After all, the whole objective of the entry was based on expectation of a generous continuation move, which hasn’t happened.

  You can’t force the market to give you what you desire. Never blame the market for getting it wrong — it all comes down to your own ability (or lack thereof) to respond to changing dynamics or conditions of the market.

The Favorite Fib strategy in action

Example 1: Buy NZD/USD

Figure A-6 shows you what NZD/USD looks like before it has reached its Favorite Fib target.

Figure A-7 shows you how NZD/USD managed to reach its target Fibonacci resistance level. Fibonacci can seem a bit like magic — the support and resistance levels really do work!

Example 2: Buy GBP/USD ahead of a key economic release

As you can see in Figure A-8, GBP/USD was trading higher ahead of a key economic release.

After the economic data release, the pound reached its target (see Figure A-9). This is another example, of how Fibonacci extensions can work in practice.

The Moving Average Crossover strategy

Moving averages are one of the most commonly used technical indicators across a wide range of markets. They have become a staple part of many trading strategies because they’re simple to use and apply. Although moving averages have been around for a long time, their capability to be easily measured, tested, and applied makes them an ideal foundation for modern trading strategies, which can incorporate both technical and fundamental analyses.

The two main types of moving averages are simple moving averages and exponential moving averages; both are averages of a particular amount of data over a predetermined period of time. While simple moving averages aren’t weighted toward any particular point in time, exponential moving averages put greater emphasis on more recent data. In this trading strategy, we focus on simple moving averages; the goal is to help determine entry and exit signals, as well as support and resistance levels.

How it works

Most trading platforms plot simple moving averages for you, but it’s important to understand how they’re calculated so you can better comprehend what’s happening with price action. For example, a ten-day SMA is calculated by getting the closing price over the last ten days and dividing it by ten. When plotted on a chart, the SMA appears as a line that approximately follows price action — the shorter the time period of the SMA, the closer it will follow price action.

A favorite trading strategy of ours involves 4-period, 9-period, and 18-period moving averages, helping to ascertain which direction the market is trending. The use of these three moving averages has been a favorite of many investors and gained notoriety in the futures market for stocks. We retain the basic concepts of this strategy but put our own spin on them and apply them to numerous markets.

First, it’s important to remember that shorter moving averages will hug price action more closely than longer ones because they’re focused more on recent prices. From this, we can deduce that shorter moving averages will be the first to react to a movement in price action. In this case, we look at simple moving averages crossing over, which may signal a buy or sell opportunity, as well as when to exit the position (we use simple moving averages because they provide clearer signals in this case). It’s important to note that this strategy should be used in conjunction with the overall trend of the market.

Entry

A buy/sell signal is given when the 4-period SMA crosses over the 9-period SMA and they both then cross over the 18-period SMA. Generally, the sharper the push from all moving averages, the stronger the buy/sell signal is, unless it’s following a substantial move higher or lower. So, if price action is wandering sideways and the 4-period and 8-period SMAs just drift over the 18-period, then the buy/sell signal is weak, in which case we keep an eye on price to ensure it remains below/above the 18-period SMA. Whereas if the first two moving averages shoot above/below the 18-period SMA with a purpose, then the buy/sell signal is stronger. (In this case, a confirmation of a strong upward/downward trend can come from an aggressive push higher/lower from the 18-period SMA.)

Aggressive traders can enter the position if they see a strong crossover of the 4-period and the 9-period SMAs in anticipation of both crossing the 18-period SMA. In this case, we recommend ensuring that all moving averages are running in the direction of the break and that you keep a close eye on momentum. If momentum starts to dwindle early, it can be an indication of a weak trend.

Keep an eye on the overall trend by using medium-term and long-term time frames. If the market is trending in either direction, then investors have to be watchful of retracements in the opposite direction. Sometimes price action can retrace sharply, which causes the 4-period and 9-period SMAs to cross over the 18-period quickly, but because it’s a retracement and not part of the overall trend, price action can run out of steam fairly quickly. A trend that’s losing momentum will become evident sooner in the short-term SMAs.

Exit

This is where the strategy becomes more subjective. Our favored path of attack from here is to judge the strength of the trend and proceed accordingly. You can wait for the aforementioned moving averages to recross each other or you can use your own judgment to determine when to exit the position. In a strong trend, it’s sometimes worth exiting the trend when it starts to head in the wrong direction over a few time periods, because sharp pushes in either direction can be subject to retracements. In weak trends, we tend to favor trailing stops. In any case, a big warning sign is when the 4-period and 9-period SMAs cross back over the 18-period SMA, especially if the trade isn’t working out as planned (that is, it’s a good time to get out to prevent possible further losses).

Stop

Ideally, a stop should be placed far enough away that it isn’t triggered prematurely but close enough to minimize losses. It’s basically there in case of a sharp spike in the wrong direction. In many cases, the 4-period and 8-period SMAs will cross over the 18-period SMA before a stop is triggered, which should be a signal to cut your losses.

Final notes

• We highly recommend using stop orders for all trades; however, placing such orders will not necessarily limit your losses.
• Look at short and multiple time frames; for instance, look at both the 10- and 15-minute charts simultaneously.
• Center your trading strategy on an effective risk-reward ratio.
• Keep an eye on the overall trend. Cautious traders should avoid going against the grain.
• Have an exit strategy before you enter the trade and wait for the signals. Don’t let emotions cloud your judgment as the market starts to move.

Investors may improve their odds of identifying trading by using this strategy in conjunction with other analysis, which can help to determine the overall trend of price action and why the market is reacting the way it is. Did price action just break a key resistance/support zone? Was there an event that caused price action to spike in either direction?

The Moving Average Crossover strategy in action

Buy example: USD/JPY ten-minute chart

Notice that there is a strong push higher in price action after the crossover and then are a few opportunities to exit the trade (see Figure A-10). It’s also interesting to note that when the 4-period and 8-period SMAs cross back under the 18-period SMA, it’s a very uninteresting crossover (price action and the SMAs are very flat), so it wouldn’t entice us to get short.

Sell example: NZD/USD 15-minute chart

Here there isn’t a strong sell signal, but the overall trend of the pair is lower, so we’re comfortable getting short (see Figure A-11). We would obviously set a stop, which is largely discretionary, just in case price action suddenly shoots higher.

Strategies for the position trader

In this section, we provide a strategy for the position trader. We call it trading the Ichimoku cloud.

How it works

You may hear people talk about trading the cloud. They’re referring to Ichimoku clouds (short for Ichimoku Kinko Hyo, which translates to “one-glance equilibrium chart”). It’s a moving average–based trend identification system composed of five different lines, two of which form the system’s main component, the cloud. Ichimoku analysis is primarily longer term and best utilized on daily or weekly charts. In addition to assisting in detecting trends, the components of the system are also very useful in identifying key levels of support and resistance. A unique feature of the cloud is that it factors in time as well as price, because the cloud is projected several periods outs.

The Ichimoku approach was developed in the 1930s in Japan by Goichi Hosoda, a Japanese journalist. Hosoda spent 30 years developing his idea before releasing his findings to the public in the 1960s. Despite the numerous components of the system, the approach is easy to understand and follow (there is a reason why it’s named the “one-glance” chart). Furthermore, Ichimoku can be used for all liquid financial markets. In this section, we cover the components and derivations of the Ichimoku system and explain how signals of varying degrees of strength are formed.

The Ichimoku chart contains five different lines with both a Japanese name and an English name that can be used interchangeably. The lines are modified moving averages because they’re calculated by using highs and lows rather than closing prices. These lines are overlaid on a price chart so that prices can be viewed in relation to the Ichimoku chart, allowing you to quickly and easily identify a trend, as well as key support and resistance levels.

The five lines of the Ichimoku chart and derivations are as follows:

• Conversion (tenkan) line: (Highest high + lowest low)/2 from prior 9 days
• Base (kijun) line: (Highest high + lowest low)/2 from prior 26 days
• Leading span 1 (senkou span A): Average of tenkan/kijun lines from prior 26 days projected 26 days ahead
• Leading span 2 (senkou span B): Daily average from prior 52 days projected 26 days ahead
• Lagging span (chikou): Today’s close projected 26 days backward

The numbers 9, 26, and 52 are used in the traditional approach. In the past, a trading week in Japan was six days (one week minus Saturday). So, 9 represents a week and a half, 26 is the typical number of trading days in a month (30 days minus 4 Saturdays), and 52 is used to represent two months of trading days.

Ichimoku’s most prominent feature, the cloud (kumo), is formed by leading spans 1 and 2. The space between the two lines creates the Ichimoku cloud.

There are a number of ways that signals can be formed using an Ichimoku chart. The most common method is to look at the price position relative to the cloud, also referred to as the simple form. A break above the cloud is viewed as a bullish signal, and a break below is seen as bearish. Price movement that is contained within the cloud shows a consolidation and, therefore, no clear trend.

Crossovers of the conversion (tenkan) and base (kijun) lines generate what are referred to as main form signals. This is similar to the typical moving average crossover where a faster moving average (the conversion line) crosses a slower moving average (the base line). When the faster moving average rises above the slower moving average, a bullish signal is generated. Likewise, when the faster moving average crosses below the slower one, a bearish signal is formed. The difference with the Ichimoku chart is that not all signals are equal. Signal strength depends on the location of prices relative to the cloud:

• Strong signal: Price above/below the cloud in the direction of the crossover
• Medium signal: Price inside the cloud
• Weak signal: Price above the cloud when a bearish crossover occurs, or price below the cloud when a bullish crossover is made

The strategy in action

Figure A-12 shows you how to trade EUR/USD using Ichimoku clouds. As you can see, this is a slightly longer-term chart — it’s a daily chart, because this strategy can favor traders who prefer a slightly longer time frame.