Start a T.A. RoutineDo Your

Homework:

By Bryan Dolan

The Official Advocate for Personal Investing Originally published March 2009. SFO magazine.

Whenever I speak at Traders’ Expos, or more frequently during my weekly Market Call

webinar at Forex.com, I’m asked about very basic technical analysis questions. Queries such

as “What chart timeframe is the best to watch?” and “What moving averages work best?” are

fairly typical. These questions come from both experienced traders and relative newcomers,

so it strikes me that a bigger issue exists here than meets the eye.

If I had to pin it down, I suggest that many traders are pursuing an unstructured approach

to technical analysis—looking at certain indicators some of the time, searching for the “right”

moving averages or seeking the best momentum study—to improve trading outcomes. But

that sounds like the perennial search for a technical “silver bullet” that does not exist. It also

reeks of putting the cart (trade strategy) before the horse (technicals), as in “I’m going to

trade the euro/U.S. dollar, what do the technicals say?”

Instead, I propose that a dedicated, systematic routine of technical analysis is a bet-

ter approach to both identifying potential trade opportunities, or setups, and successfully

managing open positions. Though the routine I outline here is centered on foreign exchange

trading, the utility of a routine applies to all markets.

Advantages of a RoutineThe benefits of a routine for technical analysis are multiple. First off, it puts the cart squarely

behind the horse, meaning the objective is to see what the technicals suggest as to potential

trading opportunities rather than selecting a market and using the technicals to justify or

rationalize a trade.

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In many respects, price developments

like a daily close above a key moving aver-

age or a bullish engulfing line on daily close

candlesticks, suggest trading setups in their

own right. Where the fundamentals may be

confused, a technical signal may offer an

otherwise unseen opportunity. Where the

fundamentals are clear (and likely triggered

the key breaks), the technicals confirm and

add conviction. But without a clear routine for

technical analysis, traders may miss signals for

potential trading opportunities.

A regimen of technical analysis also gives

traders greater overall “technical awareness,”

which is the key to staying ahead of the market

and maintaining sanity, generally speaking. For

example, rather than identifying the technical

basis for a breakdown in the dollar/yen (USD/

JPY) after the fact, a regular analysis of USD/JPY

can allow a trader to identify the triggers that

might lead to a break lower before it happens and

possibly suggest a trade setup in the process.

Along with a better technical “feel” for where

a currency pair stands, a thorough techni-

cal regimen is also likely to leave one with a

greater sense of order, even when markets turn

chaotic. Recent high volatility in forex markets

makes this even more important. In December

2008, the euro/U.S. dollar (EUR/USD) sky-

rocketed from below 1.30 to a high just over

1.47 in a matter of days, and many traders were

scrambling to keep up with the move.

But a dedicated routine of technical analy-

sis would have highlighted a number of key

technical points, one of which (200-day moving

average) effectively capped the rebound and

sparked a significant intraday reversal (see

Figure 1). On its own, that spike reversal was

a significant technical signal that a key high

had been reached, suggesting potential short

setups in the days that followed.

Candles and CloudsA dedicated approach to technical analysis also

includes daily candlestick and ichimoku chart

observations, which may reveal potentially sig-

nificant trading opportunities not highlighted

by more traditional approaches. If a trader is

unfamiliar with those approaches, I suggest he

or she study up. Lastly, a regular survey of the

technical landscape allows traders to set price

alerts at key technical points, enabling them to

stay on top of the market even when they are

not in front of their screens. But one cannot set

an alert if the analysis is not done in order to

identify the price level.

The BasicsAs its name suggests, a routine of technical

analysis refers to performing the same types

of analysis on a regular basis. But a routine for

analysis of what? The starting point for de-

veloping a regimen is to define which markets

to analyze regularly—a.k.a. the universe. In

FX, one can follow dozens of pairs, which can

be overwhelming and defeat a key purpose of

a routine, which is to streamline information

gathering, the essence of technical analysis.

For currency traders, build a solid founda-

tion by focusing on the U.S. dollar “major” pairs

(EUR/USD, USD/JPY, sterling/dollar (GBP/

USD), dollar/Swiss (USD/CHF), Aussie/dol-

lar (AUD/USD), New Zealand/dollar (NZD/

USD) and dollar/Canada (USD/CAD)), along

with two key crosses: euro/yen (EUR/JPY) and

euro/sterling (EUR/GBP).

It’s also worth following the ICE U.S. Dollar

Index for an indication of overall U.S. dollar

direction, but note that it is heavily weighted

toward Europe (77.2 percent includes the euro,

pound, Swiss franc and the Swedish krona)

and is frequently an inverted image of EUR/

USD. I’m not suggesting the pairs mentioned

are the only ones to watch, but I find they cover

the bulk of forex market action.

The main idea is to settle on the universe

of currency pairs that one is most active in

trading (or anticipates trading) and to stick

with it. One might embrace the Zen of the yen

and focus primarily on JPY-crosses (e.g., GBP/

JPY, CAD/JPY, AUD/JPY, etc.). A trader might

be a Canadian native and want to focus on all

things Canadian dollar. Traders just need to

be sure to stick with whatever set of currency

pairs they decide to follow.

Take Off the BlindersThe universe of a routine for currency analysis

does not stop with currency pairs. Given the

overlap between currency markets and other

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financial markets, I think it’s crucial to include

other key financial markets in a routine, espe-

cially as intermarket correlations have been

highly pronounced during the past year.

Here, I suggest following the CRB Index for

commodities, the S&P 500 for stocks and the

10-year U.S. Treasury yield for bonds. Due

to the sometimes high correlations between

specific commodities and the commodity cur-

rencies (CAD, AUD and NZD), I also like to in-

clude West Texas Intermediate (WTI) crude oil

futures and spot gold individually. Again, it is

up to the trader to decide which other markets

he or she wants to incorporate into the routine,

some of which may depend on when the person

is actively trading. For example, if one trades

primarily in the U.S. evenings, he or she might

consider the Nikkei as the stock index to watch.

Once a trader has settled on the universe

for analysis, it helps to set up and save chart

pages for each market with standardized set-

tings to maintain the routine. My own prefer-

ences (traders should feel free to incorporate

their own—only they know what works best

for them) are to use candlestick charts with

moving average convergence divergence

(MACD) and average directional index/direc-

tional movement indicator (ADX/DMI) studies

(stacked to provide maximum chart visibility),

overlaid with four simple moving averages (21-,

55-, 100- and 200-periods).

My rationale for these choices is straightfor-

ward enough. Candlesticks provide much more

information visually than any other charting

alternative. I like to filter a momentum indica-

tor (MACD) with a trend indicator (ADX/DMI),

relying on momentum when no trend is evident

and deferring to the trend when one is present.

The idea is to avoid getting flummoxed by an

overbought/oversold momentum reading when

a trending move is unfolding, potentially lead-

ing to a large directional price move that defies

momentum extremes.

Lastly, the four moving averages used are the

most popular in my experience, and it’s always

worth watching what everyone else is. (Why 21

and 55 instead of 20 and 50? Twenty-one and

55 are Fibonacci numbers.)

During the past few years, I have also added

ichimoku charts as an integral component of my

routine. Ichimoku charts, also known as Japa-

nese cloud charts, are mostly one big moving

average/trend identification system. [For more

information, see “Trading With Clouds,” March

2008 by Brian Dolan.] Ichimoku charts are a

separate chart form that identifies four price lev-

els that act as support and resistance, as well as

generates buy and sell signals with crossovers.

Ichimoku levels are based on daily price

moves and do not fluctuate intraday, meaning

one needs only to note the ichimoku levels rela-

tive to price to get any signals they are sending.

Making it RoutineThe first step in implementing a routine for

technical analysis is to undertake multiple

timeframe analysis. Simply put, it means per-

forming the same analysis for each pair in a

few different timeframes. My own preferences

are to focus on daily, four-hour and hourly

charts to get a firm handle on what is happen-

ing technically.

Depending on the trading style, a trader

may want to use shorter timeframes (e.g.,

two hours and 30 minutes), but I recommend

always beginning with a look at daily charts.

Even super-short-term traders who rarely

look at anything longer than a 15-minute

chart will probably want to know if prices

are up against daily trendline resistance that

dates back six months. Daily charts provide

the big picture view and highlight potentially

larger moves than any shorter timeframe. I

also suggest looking at weekly charts at least

once a month to keep a handle on even longer-

term potentialities.

In terms of analyzing each timeframe, begin-

ning with the longest and drilling down to the

shortest, I would suggest the following routine

for each timeframe:

• Pattern recognition: Inspect for key chart

formations, such as double tops/bottoms,

ascending/descending wedges or triangles,

head and shoulders/inverted head and shoul-

ders, and bull/bear flags. Remember, patterns

can appear in any timeframe. When looking

at daily timeframes, study daily candlesticks

for any patterns that may be present.

• Trendline analysis: Draw in trendlines that

capture the essence of the recent price

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direction. If a currency pair has been mov-

ing lower, for instance, a trader will want to

highlight the key resistance lines that keep

the downward move intact. Next, look to

identify likely support levels, which if broken

may lead to further declines. Then ask, if

XYZ support is broken, what’s the next likely

target? If a pair is moving sideways, look to

identify the upper and lower boundaries to

identify where a breakout may occur. Record

these levels for easy reference, but recognize

that trendlines on shorter-term charts will

move over time, depending on their slope.

• Moving average analysis: Record the levels

of daily moving averages as they will not

move during the day. Also note the hourly

moving average levels but be aware they

may move over the course of the day, per-

haps sizably if volatility is high. Moving av-

erages can be significant sources of support

and resistance, and a break is confirmed

when a period closes above/below the mov-

ing average—that is, an hourly moving aver-

age is broken with an hourly close above/

below the average.

• Momentum analysis: Look for overbought/

oversold conditions and make a mental note.

Look for bullish/bearish divergences, cross-

overs and other signs that a directional move

is stalling and potentially reversing.

• Trend analysis: Look at ADX readings to see if

trending conditions are evident in the time-

frames analyzed. Compare with momentum

analysis and where a trend is present (ADX >

25), defer to the trend reading; when no trend

is present (ADX < 20), momentum studies

tend to be more effective. Be alert for peaks

in the ADX, potentially signaling that the

trending move is stalling.

Step By StepIf traders run through these steps for all the

markets in their universe, they are more

likely to spot actionable trading opportuni-

ties than if they randomly focus on individual

markets. The trade setups may not be where

they expect, but that is the whole idea—

scanning the same universe with the same

routine is more likely to identify a technically

based trade setup than concentrating on one

or two markets, which may not be sending

any strong signals.

Timing the RoutineAnother question I frequently encounter is

“When is the best time to perform technical

analysis?” The answer to that is easy—when a

trader is square. When traders are out of the

market, they will see charts and indicators

more clearly and with less bias to any funda-

mental views they may hold.

The idea is to approach a routine of techni-

cal analysis with an open mind—listen to what

the charts are saying. Sometimes they might

not have much to say, but other times they will

speak loudly, and a trader will be there to hear

it because of a routine. Otherwise, the specific

time traders perform their routines depends

on their schedules and trading styles, but

running through a routine before trading is

always recommended.

Watch the FX CloseOne time of day that I like to highlight is the

daily close, which in FX occurs at 5 p.m. ET.

Daily closing levels frequently generate some

of the most powerful technical signals out

there. Why? Because after a full trading day,

markets have digested all manner of news and

data—price movements included—and pro-

nounced a verdict: the daily close.

If a major daily moving average or key

trendline is to be broken, traders will only

know for sure after the daily close. That’s also

when daily candlesticks are finalized (I focus

exclusively on daily candles for signals), po-

tentially presenting a tradable pattern.

It’s also when ichimoku signals are gener-

ated. For example, prices may have tested

higher into the cloud during the day, but if

they fail to close above the cloud base, a rejec-

tion may be signaled (see Figure 2).

In addition to the routine outlined earlier,

I strongly urge traders to incorporate daily

close observations as a regular part of any

routine for technical analysis. And traders

must remember to set aside time on the week-

ends to run through weekly close observa-

tions, which can pack even more information

content than daily closes.

Source: Bloomberg

This reveals a failure (blue circle) of the pound to make a daily close inside the cloud (yellow shaded area), suggesting a rejection lower. Subsequent declines below the kijun line (dark blue line) and tenkan line (green line) confirmed the weakness and kept the focus to the down side.

Figure 2: Daily Ichimoku Chart of Sterling/Dollar

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Wrapping UpMost traders practice some form of technical

analysis as part of their trading game plans, but

they may not be getting as much from it as they

could if they focus only on short-term charts,

one or two indicators or just a few markets.

By adopting a thorough routine for technical

analysis, traders can streamline their efforts

and cover more markets, potentially identifying

more solidly based technical trading setups.

Most important, though, following a rou-

tine puts the technicals squarely out front. If

the technicals are not sending any signals for

a particular market, then there is probably

insufficient cause to be trading there. But if

a market is sending a trading signal, a disci-

plined routine of technical analysis is more

likely to catch it than a less rigorous approach.

By regularly analyzing a fixed universe of

markets with a standardized approach, trad-

ers have a better chance of catching tradable

technical signals when present and avoiding

markets that do not offer such clarity.

Brian Dolan is the chief currency strategist at FOREX.com/

GAIN Capital and a 19-year veteran of the currency markets.

Dolan provides fundamental and technical analysis to

FOREX.com clients and is a frequent commentator for finan-

cial media such as Bloomberg, CNBC, Reuters and Dow

Jones. He authored Currency Trading for Dummies.

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