Forex Investment and Currency Trading

Trending and Trading Markets
Markets have traditionally been classified as trading markets or trending mar­kers, meaning they move predominantly sideways or predominantly up or down. For an excellent modern look at this conventional approach get Ed Ponsi’s FOREX Patterns and Possibilities: Strategies for Trending and Range-Bound Markets (John Wiley & Sons, 2007).

Market Environments (ME)
ME is a method for determining a more meaningful and accurate profile of any market. It is enormously useful as a complement to your trading method, money management, and performance analysis. It can also be used in what is called “quant” in the industry—risk, portfolio, and money man­ager analysis.
ME also teases out indicator-like information directly off charts without the need for calculation. Bar charts work perfectly. Market Environments was developed by Charles B. Goodman.

There are two primary MEs, two secondary MEs, and a single tertiary ME. Just using the two primaries may add meaningfully to your trading arsenal.

Directional Movement (DP) and Volatility (V)
Directional Movement is the net price change from price-time point A to price-time point B.  Draw a straight line from the low price at the beginning of the trend to the high price at the end of the trend—the direc­tional movement. This is the net price change. Note that there is price move­ment on either side of the directional movement line.

There are precise methods for measuring DP, but the core concept is sim­plicity and avoiding the calculations necessary with indicators.
Directional Movement = Price2—Price1

Volatility is the gross price movement from A to B, given a specified min­imum price fluctuation value. You may obtain a ratio with V/DP.

In the conventional classification volatility would be similar to trading.  You can plot DP and V either on a 10 X 10 matrix or use a continuum from 1 to 25: 1 is lowest V and lowest DP; 25 is highest V and highest DP. Every market can be defined as one of these 100 MEs or on a continuum.
The secondary MEs are Rhythm—Time Rhythm and Price Rhythm— and Thickness.

Price and Time Rhythm (PR and TR)
The markets very often have regular price and time rhythm. But you won’t see them if you aren’t looking for them.

For time rhythm, measure the length of time (number of time units along the horizontal scale of a bar chart). Measure bottoms to bottoms and tops to tops; make an average of each. The closer the average is to each of the specific instances, the more regular the time rhythm.

Shape (S)
To determine shape, draw a line along the significant tops of the market. You may use the same peaks you used for price rhythm. Draw a line along the sig­nificant bottoms of the market; you may use the valleys you used for price rhythm, also.

The shape forms a rough channel—Mr. Goodman called it a semaphore— in which prices have moved. Average the widths of the channel from top-bottoms.

TIP: You may not want to enter a buy side order near the top of the chan­nel average nor enter a sell side order near the bottom of the channel average.

Pretzels (PZ)
1) Draw a line between the top of a primaryswing and the bottom of a pri­mary swing; 2) draw a line between the top of a secondary swing and the bot­tom of a secondary swing; 3) draw a line connecting the tops and a line connecting the bottoms. These create pretzels, an offshoot of a charting tech­nique invented by the late, great commodity broker Eugene Hartnagle. Some­ what similar to candlesticks, the pretzels yield much information in the angles of the lines, the shapes of the two triangles, and the relative volume of the two triangles, in a unit price chart, pretzels may be made by connecting the high to the low and the open to the close, crossing the tops and the bottoms.

ME Applications 
Before initiating a trade, seek to define, even if roughly, directional movement and volatility. What do you see? Do they fit in with the conclusion you reached from the analysis of your other tools? If not, why not? Is it important?

Look at the time rhythm and price rhythm. Is the timing of both rhythms good for a trade? If either the time rhythm average or price rhythm average is off substantially, it may be good to take a bit longer look before pulling the trigger. If both are off, perhaps consider passing the trade. If it is winning trades with your losing trades. Almost all traders find they do better in some primary MEs than in others. To dig deeper, keep ME profiles for all MEs on your trades, and look for winning patterns and losing patterns.

Mutual and hedge funds, which use multiple managers, may use this last idea to allocate funds to specific managers for specific anticipated long-term MEs; managers receiving more money to trade in markets in which they excel, less In markets in which they do poorly.

Market environments may also be used to back-test systems and meth­ods using historical data. Rather than look for the usual suspects of Sharpe Ra­tio and so forth, look for methods that did well in a very wide range of market profiles.