Forex Psychology, Price Action, Correlation and COT

In this thread I would like to share my point of view on four main topics:

1. Psychology and trading mindset. If we dont understand ourselves how can we understand the market? If we cannot control our own emotions, no trading system will work for us because we will never be able to follow it precisely. "Trading in the Zone" by Mark Douglas is a must read book in this section.
2. Price Action. Instead of using a lot of fancy indicators without clear understanding what they mean, I prefer to analyze the source of all the calculations in these indicators the price itself. Bob Volman provides very good overview in his book "Understanding Price Action".
3. Currency Correlation. Because on Forex we are trading pairs consisting of 2 currencies, they both influence the performance of the trading pair in question. Accordingly there will be correlation between 2 trading pairs if they share the same currency.
4. Commitment of Traders (COT). For long term analysis we have an indicator that adds some new to our trading system, instead of recalculating the price. COT data allows us to watch the change in positions of large speculators and analyze the price action with that in mind. "Trade Stocks and Commodities with the Insiders" by Larry Williams and "The Commitment of Traders Bible" by Stephen Briese are two books I recommend.

From these four topics, Psychology is by far the most important one. To me, the other three are useless without understanding of human psyche. When we analyze the Price Action, I am not looking for some candle patterns. Instead, I am trying to think about the traders who stand behind the price movement in each candle, their reasons to be bullish or bearish, where they are likely to take profit or loss and their emotions.

COT data helps us to see the actual change in positions of really large traders, who influence the price greatly. Once again, I do not believe there is some unique trading pattern in this data that will help making money all the time. Instead, I am trying to understand their psychology as well.

A couple notes about the general direction of this thread.

1. I am not planning to provide any trading signals here whatsoever. Instead, I am planning to review the markets together and gain increasing understanding of the whole picture. The individual trade entries are up to you. In that sense, I am not really trying to show my trading system per se. I am simply trying to show an alternative view at the markets, a framework that we can operate from.
2. The discussion I would like to have here is aimed for mid to long term trading. The main analysis timeframe is weekly, with Daily being used for entries and H4 for further price action clarification (sometimes entries are taken on H4 as well). The analysis takes considerable amount of time but there should be no need to watch the live market non-stop, looking for entries.
3. I will discuss Money and Risk management as well, explaining my point of view on profit expectation and emphasizing that your goal #1 should be survival on the market. Play good defense before you play offense. I am also hoping to show that it is possibly and feasible to trade weekly trends even with a very small account, starting as low as $5000 (0.01 lots will be necessary though, but even 1:50 leverage is plenty).

Basically, the thread will consist of articles on psychology, trading business, money/risk management and regular market analysis (if all goes well, that is). We will use all major trading pairs (all EUR, GBP, AUD, NZD, USD, CAD, CHF and JPY pairs). I hope to update the first post later on with relevant information as the thread will start taking shape.t

To get started all you need to do is understand what COT is about. On my charts I use freely available indicators from Meta COT project: https://www.mql5.com/en/articles/1573
This is a big article and took me about 2 weeks to completely absorb when I started. It is essential to read it all, because the instructions on how to get started with COT indicators are there as well. My suggestion is to do it gradually, 30-60 minutes a day. The updated source code for the indicators is here: https://www.mql5.com/ru/articles/dow...14_03_2011.zip

After going through all the available indicators many times in addition to writing a couple my own I decided to go back to the basics and simply try to do a psychological analysis of market Price Action in combination with Absolute positions of Large Speculators (Non-Commercial, NC for short).

Why Speculators and not Commercials? I am interested in understanding of the psychology behind the positions and when I see the NC being heavily on the long side while the market is going down I know they are losing money and not liking it. Together with price action analysis this can be invaluable information. Commercials, as you know, may seem to lose all the time but they are on the market for different reasons - they hedge their risks. Therefore it is more difficult to predict their actions and more importantly their reasons.

Why not Net positions? Simply because I would like to see when one side starts moving, it gives me a little bit more to think about.

One unorthodox element in my analysis is that for each pair I analyze COT data for both currencies. I realize that COT data is published for currency futures and EUR COT data corresponds to EURUSD pair. However, I found that knowing the COT data for USD is just as important. On Forex we don't trade the currencies - we trade the difference between 2 currencies and so analyzing them both seems logical. This also allows me to speculate about the influence of COT on cross pairs, such as EURGBP or GBPNZD, etc.

The legend explains the COT indicator, which shows Long and Short positions for AUD and USD currencies separately. On the chart I use 3 EMAs (20, 100 and 200) and Pivot points - only to watch the price action around these potential levels of Sup/Res.
Attachment 1625729


List of abbreviations
Any currency can be abbreviated with its first letter:

1. U – USD, US Dollar
2. E – EUR, Euro
3. G – GBP, British Pound
4. C – CAD, Canadian Dollar
5. H – CHF, Swiss Franc, (because C is already used for Canadian Dollar)
6. A – AUD, Australian Dollar
7. N – NZD, New Zealand Dollar
8. J – JPY, Japanese Yen
9. M – MXN, Mexican Peso

Similarly any trading pair can be shortened to 2 letters. Examples:

1. EURUSD – EU
2. USDMXN – UM
3. CHFJPY – HJ

Support and Resistance levels:

1. S – Support
2. R – Resistance
3. SR – Support and Resistance (when referred to in general)
4. TL – Trend Line
5. Ch – Channel
6. PP – Pivot Point

Time frames

1. TF – Time Frame of the chart
2. MN – Monthly
3. W1 – Weekly
4. D1 – Daily
5. H4 – 4 hours
6. H1 – 1 hour

Commitment of Traders

1. COT – Commitment of Traders
2. NC – Non-Commercial

Phases
I see this thread going through a couple phases in course of its development

1. First of all we need to build a framework to see the market in a certain way. During this phase I am going to analyze all 28 major trading pairs on history and try to find explanation why certain moves started and ended the way they did. Here I am using the benefit of hindsight, purposely finding the ideal point of reversal first and then thinking how it was possible to anticipate it or when was the new trend confirmed inside of our analysis framework after the reversal.
   I expect this phase to continue for at least a month and there will be a lot of charts to analyze in detail.
2. Second phase is to identify certain rules of analysis that we found during the first phase and then start applying them to the current markets, by following all 28 trading pairs bar by bar on Weekly and Daily as they unfold.
3. The last phase is to identify entry points in the direction of the prevailing bias that we find while doing market analysis.

With all this in mind I want the reader to understand the purpose of the current analysis that will be posted during phase 1. There will be no trading signals to follow and any speculation about further price movement is irrelevant at this stage, as we are trying to polish the analysis framework by learning from history.

When we get to the second phase, the most important step of higher timeframe analysis is to filter out one side of the market. At any given point the trader can only do
3 things on the market: buy, sell or do nothing. The purpose of the first stage in my analysis is to filter out one of these possibilities, therefore simplifying the decision making process when a trade opportunity presents itself. Because you should always give yourself the freedom to do nothing on the market, we are looking for trading pairs where it is possible to filter out either buying or selling. That's it, as simple as that - the analysis is finished when we identified that the chances of the price going in one direction are higher than in the other.

Certainly, there are situations when buying or selling opportunities are present with similar chances of success (which is to say, 50/50) but I naturally prefer to avoid such markets and look for potential trades elsewhere.

Attached Thumbnails
Attached Image (click to enlarge)


Source.

 

Usually, each central bank has at its disposal breakeven numbers for the inflation rate, economic development (GDP) and other different macroeconomic indicators, for example, joblessness rate, which are estimated in consonance with banks' own technique. In addition, central banks compare them with the purported preferable values. In case a portion of these figures reach a breakeven number or start to change together in one or the other direction, demonstrating a certain propensity in the economy, this is considered as a signal for the central bank, that adjustments must be made to its monetary policy.