Raghee Horner examines daily directional bias and the trends in gold and the cable.

Starting all my analysis with the daily chart is a key aspect to my trading. The daily is the touchstone from which I will determine the psychology in the market. This time frame will not only dictate what my eventual entry strategy will be but also which time frames are valid for it. The daily is also the chart I use to determine what I call the Directional Bias of the market, regardless of whether I am setting up a forex, futures, or stock trade.

Directional Bias is my way of identifying and interpreting what the overall and dominant psychology of the market is - in other words - whether there is more bullishness, bearishness, or a neutral opinion of the market. I use the daily time frame because of its psychological relevance. Each time frame is important but psychological relevance comes from which time frame is most watched and therefore shapes the opinion of traders by the price action they see on it.

Consider that the GBP/USD has recently transitioned to a more bearish Directional Bias. I measure this two ways. First I look at my GRaB candles which are color-coded according the where the candles closes in relations to my 34EMA Wave. If the close is below the 34 period EMA low the candle is shaded red, if the range closes above the 34 period EMA high the candle is shaded green, and if the candle closes in between the high and low then the candle is shaded blue.

The GRaB candles are a visual interpretation of sentiment and momentum and at a glance - because of the color-coding - a determination of bullish, bearish, or neutral can be identified. There are two shades of each color. The darker shade of green/red/blue indicates a down close the way a traditional black candlestick would while the lighter shade of green/red/blue indicates an up close the way a traditional white candlestick would.

The second way, which is actually the main way, I measure the Directional Bias is with my 34EMA Wave. The three exponential moving averages I use are the 34 period EMA high, 34 period EMA close, and the 34 period EMA low and these are shown with the green, red, and blue moving averages on all my charts. The angle at which the trio is traveling is measured by what I call “clock angles”. It was important for me to have a consistent view of the angle of the Wave so the amount o f chart data included on each time frame is specific to what I feel is also psychologically relevant. I call this the market memory or lookback.

The market memory is the way that I ensure that the view that I have of each time frame and the angle of the 34EMA Wave remains consistent day to day in my analysis. Since we’re examining the daily time frame in this update, notice that the lookback for the daily is approximately twelve months. Get as close to this date as possible although I realise the charting platforms don’t necessarily allow for an exact twelve month lookback all the time. Here I have ten months and the angle of the 34EMA Wave is clearly down at what I would call a “four to six o’clock” angle.

Now the chart does not have to remain in this lookback for the entirety of the analysis but here are the items that should be considered from this view. Of course the angle of the 34EMA Wave, consider highs and lows as well as significant rallies and sell-offs, also try and determine what the overall direction has been over the past year. Again, this is specific to the daily chart. As an example, for the 60-minute chart my lookback is two weeks and I will make all the same decision based upon two weeks of price data.

Now with this information, let’s look at the recent transition in the Directional Bias of the daily GBP/USD.

Figure 1: The daily GBP/USD with the 34EMA Wave and GRaB candles indicates an overall  bearish sentiment, momentum, and trend.

For many traders the question would be how soon and when was this opinion valid? The answer lies in the culmination of red GRaB candles and the angle of the 34EMA Wave. Notice that for much of the choppy period the GRaB candles were switching from green to blue to red with fairly rapid succession as the 34EMA Wave was moving sideways in a “two to four o’clock” angle? This wide and volatile sideways range increased the likelihood that prices will exhaust around recent highs and lows and is an ideal environment to fade the ceiling and floor using a oscillator like a Stochastics to confirm the overbought and oversold levels. (My preference is the 21, 1, 3 setting.)

As the red candle began to plot, session after session, notice how the 34EMA Wave gradually began to move lower as the bearish sentiment organised into bearish momentum which in turn created the new downtrend seen on the chart now.

This important for a number of reasons: The first of which is that now I will look for opportunities to sell in to bounces on the daily preferable into the swing short zone between the 20 period SMA close (not shown) and 34 period EMA low (red). The second consideration involves how I will trade the intraday time frames. I watch the five, 15, 30, 60, and 240-minute charts and a bearish Directional Bias will dictate which charts I can get long and short on. Since the overall and dominant opinion of the market is down consider that a long entry - on any time frame - is counter-trend. Therefore I will only consider shorts on the longer-term 60 and 240-minute charts. While I can consider shorts and longs on the five, 15, and 30-miunute charts. The counter-trend entries are valid for only the short-term time frames because I do not want trade against the trend and therefore expect longer-term counter-trend organisation for my trade to follow-through. It’s akin to swimming upstream: You can do it, but not for very long without getting exhausted.

Let’s examine one more daily time frame. Gold has been moving in a sideways range since making a high on May 1, 2011 at 1576.25 as can be seen on the daily chart of the XAU/USD.

Figure 2: The current view of the XAU/USD daily chart reveals a market in distribution which is characterised by a wide, volatile, sideways range.

Notice the “two to four o’clock” angle of the 34EMA Wave which is somewhat reminiscent of the way in which the daily cable was moving before the downtrend began. Now do not assume that a downtrend ia always a result of this market trend, in fact, the prior trend must be considered as well as the fundamentals effecting the market. As a “chartologist” however I do feel that the price action reflects the fundamentals and the degree to which they have been discounted into the market.

The sideways volatility of the daily chart does set up potential fades along the ceiling and floor of the range and therefore I will use my 21, 1, 3 Stochastics to set that trade up on the daily time frames.

Figure 3: The daily chart of the XAU/USD is nearing the ceiling of the range while also nearing the overbought level on the Stochastics (21, 1, 3). This sets up a potential short sell along the ceiling if the Stochastics reaches a reading above 80 because of the “two to four o’clock” angle of the 34EMA Wave.

But what about the intraday time frames? How do you trade a market with no Directional Bias? There are two choices. One would be to steer clear of any market that does not have a bullish or bearish dominant psychology. Since it is the clarity of the market psychology that makes for better follow-through, a lack of it should be a warning. The alternative would be to focus on short-term time frames like the five, 15, and 30-minute since the market is uncertain, follow-through will be typically short-lived. Look for ways to capitalise on short-term organisation of market psychology.

I hope this sheds like on how powerful the analysis of the daily time frame can be when it comes to understanding market psychology, trade selection, and well as time frame selection.