One of the keys to becoming a successful trader is being flexible in your trading.  By flexible, I mean that you can trade effectively both long and short positions.  In this article, I will show you a strategy to identify rallies in a downtrending currency pair.

First off, we identify the trend using the 200-day simple moving average.  We are going to consider the case of price being below the 200-day simple moving average as a downtrend.  Then we will look for a series of 4 higher highs, which signifies a rally.  On the following bar we look for a negative close, which shows that the downtrend may be continuing.  Let's look at a few examples.

From the chart above, we can see that through the first week of June 2000 the Euro was rallying against the US Dollar (blue circled area).  But the price continued to stay below the 200-day moving average (in red), which means that the trend is still down.  We can see four higher high closing prices within the blue circled area (1).  Then we get a negative close on the 5th bar (2), which we look to as confirmation that the downtrend is resuming.  This sets up for a nice slide in the Euro through September.

Let's take a look a the British Pound/US Dollar for another example.  In the blue circled area, we can clearly see 4 higher high closes (1) before the move ends with a short down bar (2).  This marks the end of the rally and the price continues to drift lower through the end of the year.

This shows an extreme case of a rally under the 200-day moving average.  The Japanese Yen closes positively on 8 consecutive bars (1) before a down close (2).  This marks the top of the Japanese Yen's countertrend rally against the Australian Dollar, which continues downwards for several months. 

Feel free to send me any questions or comments that you may have.

Darren Wong
Associate Editor
darrenw@tradingmarkets.com