The Forex market, because of its sheer mass and participation, lends itself very well to charting and technical analysis. It is for this very reason that I encourage traders to focus their set-ups and trade management on charts rather than news and fundamentals. A good rule of thumb is this:

If a piece of information doesn't directly relate to a price that could be a
potential entry level, stop loss level or profit target, it is extraneous.

The end-of-day chart of the EUR / USD shown subsequently has two tools active on it: Trendlines and Fibonacci Retracement. These time-tested, classic tools answer the three questions I am asking myself when entering and managing any trade: Where should I enter? Where do I place my stop loss? Where are my profit targets?

On the May 3, 2004, the market had consolidated into a triangle pattern, and, so, we waited for a breakout to the top or bottom. The chart shows that, to the downside, we had the uptrend to break, as well as a support level, and, to the upside, we had the downtrend to break, as well as the 0.382 Fibonacci level. All chart patterns boil down to support and resistance, and that includes downtrends and uptrends.

On the May 5, 2004, we see that the market broke out to the upside and traded through the first potential profit target at the 0.500 Fibonacci level, stalling just above the 0.618, the second profit target. Each of these resistance levels become support as prices trade through and can easily be used as trailing stops. The 0.618 can now be seen as a support level and a very near-term trailing stop. Not much room for wiggle; however, it will protect profits effectively.

Traders could also use the 0.500 level. The option is certainly there, with price action supporting either level. When you consider that Fibonacci levels are generated from the last major rally or sell-off, the retracement levels are simply support and resistance.

Prices did weaken, and we see that the 0.618 level was, indeed, the reversal level, and prices have closed below the 0.500 Fibonacci level, thus closing out the long position.

The next chart shows the view as of the 10th of May. The EUR / USD has continued to sell off, and a large consolidation pattern (a downtrend and uptrend trying to converge) has begun to develop. Prices are currently trading at the 0.786 Fibonacci level and had bounced off the 0.886 level earlier. Having these levels on the chart helps a trader gauge the strength of the market, and they act as potential support and resistance levels laid out on the chart.

Confirmation of a potential break of the uptrend line would coincide with the 0.886 Fibonacci level. There is also a support level at the 1.000 (full retracement) level. This support level would be the first potential profit target level if prices break down below our entry level at the 0.886 level.

Let's rewind and take a look at this set-up on an intraday chart.

The intraday view is of the 180-minute chart. I will scan through the 15-, 30-, 60-, 180- and 240-minute intraday. Here, we see prices resting right on the uptrend line. To the upside, we see a minor resistance level not far from the 0.618 Fibonacci level. The uptrend line and the minor resistance level are forming a rising wedge.

Here's the view seven candles later.

Prices broke the uptrend lines, and the sell-off sliced down through the first profit target at the 0.786 Fibonacci level and are heading toward the second target at the 0.886.

The next chart is just four candles later and shows a great example of when prices fall short of a target and what can happen.

Here, we see that the low reached 1.1807 while the profit target was 1.1804. Three lousy pips, but that's the way trading can go. Because we have the 0.786 Fibonacci level just above, it makes for a perfect trailing stop.

Let's take a moment to talk about execution. Remember: Because we pay the "spread" in Forex, we're usually dealing with about a four-to-five-pip difference between the bid and the ask. This means we have to think about where our order will be waiting among the other orders in the "market depth."

Returning to the scenario previously described, with the profit target of 1.1804, this order would be placed as a limit order to buy (a "bid") at 1.1804. With a five-pip spread, the 1.1804 bid would be trading versus a 1.1809 ask. So, consider that, when the bid is 1.1804, the price that a trader could exit at or "hit the ask" would be 1.1809. When 1.1804 is the ask, the bid would be 1.7999. Remember: We pay the spread when trading Forex.

*Reprinted (and modified) with permission from Raghee Horner of EZ2TradeSoftware.com